Archive for the ‘Views on news’ Category.

 

A few of you may have noticed the frenzy around the NBFC and especially the MFI (micro finance institutions) space. The buying frenzy is not entirely irrational.

The Indian household debt at around 9-10% of GDP is among the lowest in the world and there is a huge pent up demand in the retail / MSME segment. The introduction of adhaar, regulatory changes and several new technology tools is now allowing the NBFC segment to reach new customers at a much lower cost and achieve rapid growth.

We are now seeing growth in excess of 40% in this space. This is further aided by the fact that PSU banks and to a certain extent some private sector banks, are not capable or interested in serving these customers.

So we have a confluence of factors coming into play here – A new regulatory and technology platform which allows companies to reach out to a large set of under-served customers at a time when the dominant players in the ecosystem, namely banks, are not in a position to take advantage of these opportunities.

We are seeing this playout in the entire financial services space – Home loans, NBFC, Auto finance and even structured finance. This is likely to continue for the next 2-3 years.

Tread with caution
There is however a dark side to this whole opportunity – A growth of 30%+ may lead to poor lending practices and weak credit underwriting in several cases. This may be truer in the case of newer institutions which lack the experience and management bandwidth to manage this growth (and later collect the bad debts).

We may not see the impact of these practices for the next 2-3 years, but if poor decisions are being made, the chickens will eventually come home to roost. We have seen that in the past in the sub-prime mortgage crisis in the US and the bad debt problems of the PSU banks now.

The time to be cautious is now and not when the poor lending practices lead to a blow up in the future. In other words – tread with caution and be sure what you are buying.

What are we doing ?
We are already around 20% of our model portfolio in financials via four companies. These companies operate in different segments of the financial ecosystem and I believe that the management of each of these companies is competent and has seen multiple cycles in their respective businesses. At the same time, if the frenzy continues and our concentration in this business segment continues to grow, I will start reducing the position size.

For now, we are not there yet and hence I am not taking any action.

 
 

The flavor of the month has been the launch of Nano by Tata motors. The Nano launch got an extremely wide coverage in media, which is something only Apple’s products are able to get.

My interest around the launch of Nano has been more in terms of the impact on Maruti suzuki. Maruti suzuki is a holding for me and I have analysed the company in the past ( see here and here ).

The percieved threat to Maruti from Nano has been known for quite sometime now. The reason I use the word percieved is due to the fact that I don’t consider this as an immediate threat, but a long term one. Let me explain

The product which is supposed to be impact by Nano is Maruti 800. However this model has been in a state of decline for the company for the last couple of years. In the year 2007, even before the launch, the product had volume decline of 10%+ and now accounts to barely 10% of the sales volume and must account for less than that in terms of profits (I don’t have the profit contribution for Maruti 800, but we can safely assume that the margins for this model are less than the higher end products). As a result, Maruti suzuki seems to be consciously moving out of the lower end of the market and the launch of nano could accelerate the process. Any further loss of volumes in Maruti 800 should not hurt the company much.

So much for the short term. What about the long term ? That is different story. For reference, let me point out the book – The innovators dilemma by Clayton M. Christensen, which talks in detail about disruptive technologies. I cannot explain the key concepts in a short post and would recommend reading the book or using this link.

The key point is that some companies introduce disruptive products at the low end of the market which meet only a subset of the requirements and cannot meet the requirements of majority of the users. These disruptive products or technologies are ignored by incumbents, as they are cheap, low margin and a threat to the current business model and products. However with the time the disruptive companies keep improving these cheap, disruptive products which then become good enough to threaten the mainstream products. A well know example – Personal computers.

Tata’s nano can be a disruptive product in the long term. As of now, this product will not threaten Maruti suzuki and other companies or their profits. But if Tata motors gets it strategy right and keeps improving the product, then they could be a major threat to the other companies.

It is however not a given that the above will happen. It will depend on how the other car companies react. However irrespective of the response, if the Nano is successful, it will affect the profitability of most of the car companies in the long run. I would recommend reading – Clayton M. Christensen’s books to understand how this has typically played out in other industries and you will appreciate how the same could happen in the car industry.

All of the above is still in the future. For the time being, everything is bright and sunny and investors like me in maruti suzuki are not complaining. However, due to the above market dynamics I do not plan to hold the stock for more than a few years (yes my concept of long term is more than a few months 🙂 ).

 
 

I recently read the news on suspending AS11 accounting standards for the next 2 years in view of the dramatic changes in international markets. In the last one year, the rupee has suddenly depreciated from 40s level to 50s declining by more than 20% during this period. Most of the companies were caught by surprise as they did not expect the rupee to depreciate so sharply and hence are facing MTM (mark to market) losses for the current year.

AS11 is a standard for recognizing impact of forex changes on the company’s accounts. I have the discussed impact of forex changes in my discussion of NIIT tech. I have said the following in the past

The current quarter results show a bottom line drop of around 50%, mainly due to forex losses. I do not consider them as core losses (just as forex gains are not permanent gains). I have seen a lot of people get all worked up about forex losses, which does not make sense to me.

Unless the company is speculating on forex (via non effective hedges), I think the forex gains and losses should even out over the period of few years and hence one should be concentrating on the core profits to value the company.

As an example look at the results of the airlines such as southwest (in the US). Southwest airlines has been consistently profitable for the last 20+ years. They have had 2-3 quarters of hedging related losses due to oil price volatility. Do you think they have a problem in their core operations?

So if I have considered these losses to be temporary, akin to a bad bet, then why am I not applauding this temporary suspension of the standards?

The reason is simple – I want my companies to give me the true picture. Don’t fudge, whitewash or hide information from me (as an investor). Please tell me the whole truth and leave it to me to judge the impact of it. As investors we are smart enough (as a group) to judge the impact of forex changes on the long term economics of the companies and don’t need the companies to whitewash this information for me.

Now that we are in the territory of fantasy accounting, I have a few more proposals
–        Ignore cost increases of raw material when they become too high. When steel prices increase sharply, all auto and other companies should be allowed to ignore price increases
–        Ignore manpower costs and salary hikes. Allow all IT companies to ignore salary hikes in excess of 5%.
–        Ignore depreciation after a huge capex. Whenever the company puts up a new plant or makes a big accquisition, allow it to ignore depreciation and amortization expenses

I could go on and on. The above change is self serving and will only muddy up the numbers. It allows the companies to present the numbers in a good light and ignore reality. Is it a given that the rupee will appreciate to 40s level in 2 years and all will be great in the fantasy land?

I personally don’t care what companies report by suspending AR 11 for 2 years. I will personally adjust the numbers of the companies I have invested in or plan to, based on the forex changes.

I really wish I had this flexibility when I was studying !! I would have asked the examiners to ignore all the question I got wrong  and I would have always got 100% in all my exams 🙂 . Life would have been good !!