Archive for 2014



FREE FALL OF OIL PRICES AND INDIA

Written by HARIKRISHNAN.T
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On 27th November 2014, a meeting was conducted in Vienna by the OPEC (Organization of Petroleum Exporting Countries) to decide on whether to cut the production of oil in order to support the falling global oil prices. But they were unable to reach into an agreement because of the opposition from Saudi Arabia.

 So the first question that has to come to every one’s mind is what is the reason for the recent free fall of global oil prices?

 To answer this question, first we have to get an idea about shale oil. Shale oil is unconventional oil produced from oil shale (Oil shale, also known as kerogen shale, is an organic-rich fine-grained sedimentary rock) rock fragments. That means if a country has large amount of oil shale reserves, then it can also produce oil. But the problem is the extraction of oil from oil shale. It is a very complex, capital intensive process and the cost of producing oil is much higher compared to the traditional methods.

 US has significant amount of oil shale reserves in their country. Still they didn't produce much oil using this method because of the high costs. But the picture started to change five to six years back. When we consider the oil prices from the period 2010 to 2014 we can see that the price was settled somewhere around $100 per barrel.
This was because of the demand from China and other emerging economies was good and there was some bottlenecks from the supply side because of the political uncertainties from Libya, Iraq etc. This has helped demand to stay always above supply and as a result the price was settled around $100 per barrel for a long period of time.

Price of crude oil WTI. Data obtained from www.nasdaq,com

US energy companies smelled this as an opportunity to extract oil from oil shale. Because they estimated that if the price of the oil is in the $100 range, then even after considering the huge costs associated with the exploration activities, they can still make a decent profit. This insight helped the US energy companies to pump billions of dollars into shale oil production and they have received lot of capital. As a result the share of US in the global oil market has been increased dramatically. US were producing about 4 million barrels of oil per day till 2008. Since then it has been increased to 8.97 million barrels per day at the end of October 2014.

 Situation was good till last September. But it started to change from September onwards. Political chaos in many countries started to abate. Libya’s production has recovered from 200,000 barrels a day in April to 900,000 barrels a day, while war hasn’t stopped production in Iraq and output there has risen to an all-time high level of 3.3 million barrels per day. At the same time global economy started to experience some sort of setbacks. Demand from China, which was the growth engine of the past decade got reduced. Similar trends were seen from all over the world. This lower demand coupled with an excess supply from US and other oil producing nations caused the oil price to fall from $100 levels to $65 levels.

 The next question is why Saudi Arabia is not ready for a cut in oil production. Because they fear that if OPEC cut production, the price will again climb back to the previous levels and as a result they may lose the competitive edge in the global oil market because of the supply from US. The Bloomberg report written by Grant Smith reports that US is on its path to become the biggest oil producer in the world by overtaking Saudi Arabia (Full report can be read from here http://www.bloomberg.com/news/2014-07-04/u-s-seen-as-biggest-oil-producer-after-overtaking-saudi.html)

 So Saudi Arabia needs to make the shale oil production in US unviable and unprofitable by making the crude oil price lower. But there is a very serious negative reaction to this. The major source of revenue for most of the biggest oil producing nations is from the oil trade. So if the price continues to hover around these levels, then it is going to have a very tough time for their economies, because they may have set their economic and public policies on the assumption that they will get around $100 per barrel for oil. So the revenue short fall will be huge. 

 A report from outside the box (Full article can be accessed from here http://d21uq3hx4esec9.cloudfront.net/uploads/pdf/OTB_Nov_26_2014.pdf) by Jawad Mian says that the current oil decline has potentially cost OPEC $250 billion of its recent earnings of $1 trillion. This explains the magnitude of the situation. At the same time in the same report he shared one interesting observation. Even though 50 percent of shale oil is un-economical at current prices, the median cost of producing shale oil came down to $57 compared to $70 last year.  That means even at these price levels US can produce oil economically. So we are going to see a huge price war in the oil sector in the coming years.

 How India will be affected?

 Everyone knows that India is a net importer of petroleum products and we imports around 70 percent of our crude requirements. So this price falls going to be very positive for our nation.

 Our current account situations will be improved because oil is the biggest contributor of our import bill. Every dollar fall in oil leads to 4000 crore saving for India.

 Also this is going to have a positive impact on our inflation front too. According to a RBI report (2005), for every unit dollar increase in crude oil price, WPI inflation rises by 30 basis points. Obviously every unit dollar decrease should also have some positive effects.

 Economists around the world predict that this is not a temporary phenomenon. This price level will be maintained in the years to come. For India “acche din aane wale hai” :)

 References

http://d21uq3hx4esec9.cloudfront.net/uploads/pdf/OTB_Nov_26_2014.pdf
http://www.bloomberg.com/news/2014-07-04/u-s-seen-as-biggest-oil-producer-after-overtaking-saudi.html
http://www.vox.com/2014/11/28/7302827/oil-prices-opec
http://en.wikipedia.org/wiki/List_of_countries_by_oil_production
http://en.wikipedia.org/wiki/Oil_shale_reserves
http://en.wikipedia.org/wiki/List_of_countries_by_recoverable_shale_gas
http://en.wikipedia.org/wiki/Shale_oil
http://en.wikipedia.org/wiki/Oil_shale





When TCS is the cash cow of Tata Sons

Written by HARIKRISHNAN.T
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Tata consultancy services again came into the lime light last week by announcing a strong first quarter results and becoming the first Indian company to achieve the 5 lakh crore mark in terms of market capitalization. The competitors to TCS such as ONGC, Reliance, ITC etc. (in terms of market cap) are far below the level achieved by TCS. 

So I just wanted to check how much TCS is worth to Tata Sons compared to other Tata group companies.

For that I took 12 major Tata group companies and collected their market cap (for July 24, 2014), Net sales and net profit. (On a consolidated basis as on FY14)

The following interesting facts have been observed.



The combined market cap of 12 Tata group companies are 814,681.81 lakh crore (as on July 24). The biggest contributor is obviously TCS with a whopping 62.2 percent share in total market cap. The next biggest gainer is Tata motors. But its contribution is 19.11 percent almost one third of TCS.

The next thing I considered is the net sales and net profit (in a consolidated basis as on FY 14).



The revenues of 12 major Tata group companies for FY2013-14 was at 562,496.87 crore in which TCS contributed to just 14.83 percent. Tata motors were the biggest contributor with a 41.86 percent share followed by Tata Steel with 26.6 percent. But when we come to net profit scenario, TCS contribution was 51.16 percent of the total net profit (total reported net profit by these companies were 37,787.83 crore as on FY14) reported by these companies. Tata motors secured the second position with 37.32 percent share (But most of its profit and revenue came from JLR) and Tata steel came third with a meager 9.7 percent. Interesting isn’t it? The important factor to consider in this scenario is even though TCS contributed a meager 15 percent to the Tata Group companies’ (that I have considered) revenues; TCS contributed a whopping 51.16 percent share in net profit.

From these figures it is pretty much clear that it is this single IT service company that have enabled Tata Sons to keep investing in group companies. Tata group companies especially Tata steel and Tata motors have huge debt in their books mostly because of the acquisition of JLR by Tata motors and Corus by Tata steel in 2007. The situation got worsened because of the global recession in 2008. Even though the JLR contribute significant amount of bottom line to Tata motors, the performance of Corus is quite disappointing. Even though Tata steel posted a net profit of 3663.90 crore in FY14, it reported a net loss of 7,362.39 crore in the FY13 (in a consolidated basis). Apart from this the recent announcement of Japan’s Docomo to quit the partnership with Tata Tele services which they had in the telecom space and the recent decisions to enter into the aviation sector with Air Asia and Singapore Airlines also need a lot of money. Recently announced dividend payout of Rs. 12750 crore by TCS, the highest ever dividend payout by an Indian company should be seen in this regard. Tata sons will get around 9300 crore from this dividend payout since they have around 74 percent stake in TCS which they can utilize for investment in group companies. 

So TCS is and continues to be the lender of the last resort for Tata group.

Views are personal :)

Data collected from moneycontrol.com, firstpost.com and the respective company websites.



ALL THAT GLITTERS IS NOT GOLD

Written by HARIKRISHNAN.T
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India’s current account deficit (CAD) for the January-March period narrowed sharply to $1.2 billion (0.2 per cent of GDP) from $18.1 billion (3.6 per cent of GDP) in the same period last year, which was also lower than $4.2 billion (0.9 per cent of GDP) in the October-December quarter of 2013-14.

 When we observe the figures of current account deficit, we could easily figure out reduction in current account deficit is mainly attributed to the reduction in gold imports, which amounted to $ 5.30 billion, lower than $15.80 billion in the fourth quarter of 2012-13. Thanks to the measures taken by the UPA government to control the import of gold by increasing the excise duty from 2 to 6 and eventually to 10.

So the question comes to everyone's mind is that is this measure to control the current account deficit by controlling the supply of gold is sustainable? The answer is obviously no. It is pretty much clear that although government has taken stringent measures to control the import of gold, the fantasy of Indian households towards gold as a safe haven to beat inflation has never receded. So the only thing we can do to curb the obsession of gold is not to cut the supply but to curb the underlying demand. How can we achieve that?



In order to find the ways to control the obsession of gold, first we have to consider why people are considering gold as a superior investment vehicle.

Traditionally Indian middle class investors tried and tested the following asset classes

Bank deposits
Equity and equity oriented products
Gold

Most of the people got their fingers burned by investing in equities.

The first reason was that most of the first time investors usually start equity investment at the tip of a bull market. The reason can be attributed to different media that gives much more hype to the stock related news. News like ‘Nifty touched all-time highs, investors wealth multiplied by several times’ obsess first time investors and they take their exposure in equities for the first time on the assumption that equities can deliver superior returns in a short period of time. This euphoria can be seen everywhere. But the investments that they make will be in overvalued stocks because bull markets will stretch the valuations of stocks to unprecedented levels and since they make most of their investments at the peak of a bull market, eventually they will end up in loss as graham said all the bull markets will eventually end in an unjustifiable bear market.

Second reason is that attitude of most of the people is that they need quick profit. While investing in equities they are not considering the fact that investment in equities means investment in companies and the profit won't come in a day or two.

Third reason is even though people have long term financial goals, they are unwilling to take short term losses which are apparent in equities.

Because of all these factors, people consider equity investments as an investment vehicle to lose money. As a result traditional savings methods like gold and bank deposits got much more exposure than it ought to be.

In the last decade especially in the past 4 years, our country has been experiencing stubbornly high inflation. Consumer price index based inflation is somewhere around 8 to 10 percent for the past couple of years. People realized that bank deposits that gave a mere return of around 7 to 9 percent will not be enough to beat the inflation. So the exposure towards gold increased further based on the assumption that gold can give superior returns which is capable of beating the inflation.

So coming to the central topic of this article, how can we curb the demand of gold or more precisely how can we reduce the exposure towards gold in one's portfolio thereby making our balance of payments much more stable? There could be many ways but in my view the most effective way is to encourage people to invest in financial products such as equity and equity oriented products, debt instruments etc. rather than in physical products, teach them about various financial products available, make them aware of the benefits of investing as well as the risk factors involved. Encourage them to save for long term. Also make them aware that investment in equities can generate substantial capital appreciation in the long run. As nation progress everyone should get exposure towards formal financial system. This exposure towards the formal financial system will eventually help people to understand the various asset classes and the benefits of investing in various assets and also the risk involved. So in the long run exposure towards physical assets will reduce marginally and the people will allocate more exposure towards equity. Thus the financial markets of our nation will flourish and it will definitely going help to help our economy in a positive way. I know this is not an easy task and it requires Herculean efforts from concerned departments. But we have to take short term pains for a stronger and incredible nation.

I firmly believe in the long run no asset class can give the returns which equities can give. Take the past 20 or 30 years of data and you will come to know. But past returns does not necessarily mean that it will continue in the future. But as an investor we should and have to believe in a better tomorrow :)

It does not mean that I loathe gold. What I believe is the exposure of gold in our portfolio should not exceed 10 percent of the total portfolio value.


So to conclude curbing demand of gold by cutting down supply is not an option in the long run, even though it may work in the short run. The effective way is to curb the demand itself by making citizens aware of the various financial products apart from gold.

Views are personal :)



Performance of Nifty stocks – Views of a Rookie Investor

Written by HARIKRISHNAN.T
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Nifty is making fresh new highs every day. Market participants are very much excited and most of the participants feel that it will touch even 7000 in the weeks to come even though macroeconomic indicators such as interest rates, Factory production, GDP growth, inflation are not so good.

Even though Nifty is at record highs, many stocks that constitute the index are still trading far below from their all-time high. So I just wanted to check the returns given by the stocks.

For that I took the closing price of all Nifty stocks on 28-Aug-2013 (on that day Nifty hit a 52 week low of 5118.85) and closing price for the same on 23-Apr-2014 (On that day Nifty hit a fresh high of 6861.60). I haven’t taken Tech Mahindra Ltd, United Spirits Limited, Jaiprakash Associates Ltd and Ranbaxy Laboratories Ltd as with effect from March 28, 2014, Jaiprakash Associates Ltd and Ranbaxy Laboratories Ltd have been replaced by Tech Mahindra Ltd and United Spirits Limited respectively. Kindly note the fact that the following stocks may hit a much higher price in this period compared to the closing price of 23-Apr-2014, but since Nifty hit a fresh high on 23-Apr-2014, I have taken that particular date as a reference for the calculation.

After that I took the annualized returns of all these stocks for a period of 246 days from the start date to the end date, end date included using the formula

(End value - Beginning value)/Beginning value) x 100 x (1/ holding period of investment in years)

(Value on 23-Apr-2014 - value on 28-Aug-2013)/ Value on 28-Aug-2013) x 100 x (1/ (246/365))

(246/365) is used in the formula for getting the holding period in years.
All annualized returns are represented as “% p.a.”
The below are the details for the same.


Best Performers


Worst Performers

The following conclusions can be derived from the above.

FMCG stock HUL did not give superior returns over this period. Even though ITC has given a return of 27 percent, these stocks under performed many other stocks of the index. The reason could be their high valuation and also they had a fantastic return over the past couple of years.

Software stocks also did not give much return in this period (Except HCL Tech). Even though Infosys touched a 52 week high of 3849.95, the stock had witnessed a sharp correction from there on. Even though the IT spending in the US and European regions are increasing, the sharp appreciation of rupee against the dollar, much more competition from the small players and obviously the high valuation were the primary reasons for the under performance.

Banking and Finance stocks gave decent returns over this period. Private sector banks such as Axis bank and ICICI bank outperformed public peers despite of their higher valuations. Interesting point to be noted is that public sector banks Bank of Baroda and Punjab National Bank gave returns of over 120 percent despite of their much higher NPA and stressed assets. The main reason for this stellar performance can be attributed to their low valuations, which means that value investors are accumulating undervalued stocks. State Bank of India was the worst performer in the public sector banking space and Kotak Mahindra from the private sector space in this period (Among Bank Nifty stocks).  Further upside in ICICI bank and Axis bank will be capped as FII limit in these stocks has reached the maximum limit. SBI has much more potential upside considering this. But their nonperforming assets are an area of concern.

We can see that pharmaceutical stocks are also struggling to make returns over this period considering their much higher valuation. But we should not forget the fact that these stocks gave decent returns in the past when other stocks are struggling to give even some positive returns.

The trend from FMCG, pharmaceutical and IT is clear that investors are taking their positions from these defensive bets to other cyclical stocks over this period.

In the 48 stocks that I considered from Nifty, only one stock gave negative returns over this period. It is NTPC. The reason for this is issue regarding to power price regulation and all. But since NTPC is the largest power producer in the country and has a good past performance as well as a good balance sheet, it should give better returns in the long run.

Power generation companies Tata Power and Power grid Corporation managed to get 18 percent returns over this period which is very low compared to other stocks.

Real Estate major DLF managed to get 22.93 percent returns during this period. But these returns can be attributed to rising tide sentiment as a rising tide lifts almost all the boats. The company has a lot of debts in its books and the overall real estate market has taken a hit because of the higher interest rates scenario. Probably that could be the reason investors are staying away from this stock.

Metal stocks which are infamous for their cyclical behavior gave some average returns during this period but not much. Even though Tata steel gave a return of 78.46 percent, the stock is still trading way below its all-time high. I think the lower valuation as well as improving global sentiment should take these stocks into much higher position.

Always remember even if the bear market is catastrophic enough to take stocks into historical low levels, there will be a much strong bull market to take back these stocks into new fresh highs because market is a pendulum that swings between unjustifiable pessimism and unbelievable optimism.
The views are personal. J



How much insurance cover you need

Written by HARIKRISHNAN.T
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Life insurance is a contract between an insured and an insurer, where the insurer promises to pay a designated beneficiary a sum of money in exchange for a premium, upon the death of the insured person. Basically insurance is a particular type of risk management.

 So the question comes to everyone’s mind is that how much insurance cover a person require, in order to compensate the financial loss the family suffers in case of his death.

 Let’s take an example to explain this.

 Raju is 30 years old working in a multinational company. His wife is a home maker. They have 2 sons aged 1 and 3. His salary details, assets and liabilities are listed below.

All figures are in INR

Gross monthly income after deducting PF, income tax etc.
50000
EMI towards car loan
5000
EMI towards home loan
10000
Net income available to family
35000

After deducting the EMIs for car and home, the net income which is available to Raju is 35000 per month at this particular point of time.

 This income (INR 35000) will be utilized for day to day activities, food, clothing, entertainment, emergencies, and the balance amount after all these will be saved.

 In case of the unfortunate demise of Raju, the inflow of cash that Raju generates for his family (35000 per month at this particular point of time) will be stopped.

 So the insurance cover that protects Raju should be roughly equivalent to the sum of all his future cash flows that he may generate, if he lives till his retirement.

 In order to calculate this we have to consider the following parameters.
                    1)      Retirement age
                    2)      Approximate hike in his net income on an yearly basis

 We are assuming that he is planning to retire at the age of 55. He expects that his increase in net income will be 6% annually.

 The following table gives his expected annual net income for a period of 25 years (currently he is 30 and his retirement age is 55).




In the first year his net income per month is 35000. So annual income for the first year will be (35000*12) = 420000.

 Since he expects a 6% hike in his net income, annual net income for the second year will be
(Annual net income for the 1st year) + ((annual net income for the 1st year)*6/100)
420000 + (420000*6/100) = 445200

 Similarly for the third year, annual net income will be
(Annual net income for the 2nd year) + ((annual net income for the 2nd year)*6/100)
445200 + (445200*6/100) = 471912 and so on.

 Since the EMI towards car loan is for 4 years, from the fifth year onwards a sum of (5000*12) = 60000 can be added to his net income.

 Also since the EMI towards home loan is for 20 years, from the 21st year onwards a total of (10000*12) = 120000 + 60000 (towards EMI of car) = 180000 can be added to his net income.

So the updated net annual income after adding these amounts will be



Sum of net annual income earned by Raju in the next 25 years, assuming an increase of 6% annually will be 24903095.02 

 Since these cash flows occur at uneven interval of time, we have to calculate the net present values of all these future cash inflows Raju may produce, if he is expected to live at least till his retirement.

 In order to find the present values, we have to consider three important parameters.

                        1)      Retirement age
                       2)      Expected rate of return
                       3)      Inflation

Impact of inflation

In economics, inflation is a sustained increase in the general price level of goods and services in an economy over a period of time. So over time, the value of one unit of money will go down because of the inflation effect and the same amount of money will not be able to purchase as much with that unit of money as he could have purchased earlier. In other terms, inflation eats away purchasing power over time.

 So if we didn't consider inflation factor while calculating the present value, it may produce erroneous results and will have a negative impact on how much insurance cover he requires.

 We are assuming that inflation for a period of 25 years will be averaged at 6 percent per annum and the rate of return for this period will be averaged at 15 percent per annum (assuming that the average equity oriented mutual fund may generate this return over this period).

 So the inflation adjusted return for calculating net present value will be

 ((((1 + expected rate of return) / (1 + inflation rate))-1)*100)

 ((1+15/100) / (1+6/100) – 1)*100 = 8.4905%

 To calculate the net present value, we can use MS Excel.

 Steps for calculating net present value in MS Excel is given below
              
                    1)       Open MS Excel and enter all the cash flows (this case his annual income over a period of 25 years) 



Click on a blank cell and enter the following
=NPV (8.4905%, B1:B25)

 The first argument is the inflation adjusted return. (Always remember to add % sign at the end of the first argument)

 Second argument is the values for which we have to calculate the net present values. Since here the values are spread across cell number B1 to B25, we will mark it as B1:B25



After entering the command, press Enter and the value we get is the net present value.

 In this case the net present value after executing the command is 7,938,108.08

 In other words, this is the present value of all future cash flows Raju may generate if he lives till his retirement or this is the financial loss of the family if Raju die today.

 Next we have to consider his assets and liabilities.

 His assets (current assets as well as fixed assets except the car he owns and the house he lives in) and investments includes

 Fixed deposits PF and debentures worth 10 lakhs
Gold worth 5 lakhs
Shares and mutual funds worth 3 lakhs
Plot worth 20 lakhs
Insurance cover of 10 lakhs
Total assets = 48 lakhs

 His liabilities are

 Car loan (EMI of 5000 for 4 years) – (5000*48) = 240000
Home loan (EMI of 10000 for 20 years) – (10000*240) = 2400000
Total liabilities = 26.4 lakhs

 So the adequate insurance cover he has to take is

 (Net present value of his future cash flows + liabilities – current assets and investments)

 7,938,108.08 + 2640000 – 4800000 = 5778108.08

 Approximately 57.7 lakhs (on the assumption that he may die at this point of time)

 The below mentioned calculation is based on my assumptions and conclusions. Investors are advised to consult financial consultants before taking insurance policies/making financial decisions.

 Views are personal :)