Corporate Debt:33% find it difficult to repay

Ask anyone how they would avoid investing in a leveraged company. Chances are that nine times out of ten, you would be advised to look at the company's debt to equity ratio. If it is within safety limits, the firm can be considered as a good candidate for investing. What doesn't get analysed often is the issue of liquidity. For if the company has built long term assets with relatively shorter term funding, there is a risk that the company may run into cash flow problems if the old debt is not refinanced. Alternatively, if the assets don't start generating revenues soon enough, even then the company could run into trouble. 

The Economic Times reports how it is this latter issue that is giving lenders and borrowers sleepless nights these days. Sample this. As on September 2013, listed companies had total borrowings to the tune of Rs 24 trillion. And out of this, a whopping one third was with companies where interest costs exceeded the operating profits earned during the quarter! And the problem, as highlighted earlier, is not that of solvency but mostly of liquidity. In other words, thirty year assets were built with 10-year money with the borrower expecting money from the eighth year onwards. Well, the indebted companies will have to quickly offload other assets or somehow find new sources of funding to replace old debt. If not, we could well be staring at a crisis of huge proportions. 

Going by this parameter stocks are not expensive

That Foreign institutional investors (FIIs) are interested in Indian stocks is not something new. The fact that their stakes in large Indian companies have increased over the past few quarters is something that proves this point. On the other hand, the actions taken by domestic institutional investors (DIIs) are quite the opposite. In the year till date, their net outflows stood at over Rs 732 bn. As per the Business Standard, this is probably the highest sold by such institutions in about 9 years; data prior to 2004 is not available. The earlier record was about Rs 570 bn in 2012. On the other hand, the net inflow by FIIs stood at Rs 1 trillion during the year. This is their third highest figure of such inflows reported in a year. 

One may argue that redemption pressures, which may have led to a situation of net outflows by DIIs, must be taken into consideration here. Not to forget the outperformance of other asset classes, coupled with profit booking (with the BSE-Sensex touching its highest levels recently) as reasons for investors pulling their money out of stocks. 

I believe this should ideally be the situation that investors should be taking when the markets seem overheated. Sure, the markets have touched new highs, but does that mean they are expensive? 

Warren Buffett is of the belief that the best single measure for gauging the attractiveness of stocks in an economy is the 'total market capitalisation to GDP ratio'. The lower it is the, more attractive the stocks are in that market. The higher it is, the more expensive they are. 

If one were to view valuations by this parameter, stocks look anything but expensive at the moment. At the end of FY08, the figure stood at about 106%, which indicated an overheated situation. Post the market decline, the figure fell close to 55% levels at the end of FY09. Going by the chart below, valuations picked up quickly thereafter. However, in recent years the ratio has moved lower. As of a couple of days ago, India's market cap to GDP ratio stood at about 64%, which is pretty much close to its thirteen year average. 

Going by this parameter, stocks are not expensive

* As of December 23, 2013; It may be noted that the business daily has estimated the FY14 nominal GDP growth rate to be 12% (5% growth + 7% inflation).

What does this suggest? A short answer would be that one can consider investing in stocks at the moment. 

But when one views valuations of the different indices, it paints a slightly different picture - for the blue chips mainly that is! The BSE-Sensex trades at a multiple of about 17.8 times its trailing twelve month earnings, which is slightly above its long term average. Comparing this to the BSE-500 index, which comprises of the large cap companies in India, valuations are lower at about 15 times. Now, considering that the bluest of blue chip companies form a significant portion of this list of 500 companies - in terms of market capitalisation - it would be fair to assume that the collective valuation for the balance large cap companies would be much lower.

Also, if one looks at the smaller companies, i.e. stocks forming part of the BSE-Midcap and BSE-Small cap indices, they seem all the more attractive. Given the volatile earnings reported by them in the past few quarters, looking at these companies on a P/E basis may show a distorted picture. But when seen on a price to book value basis, stocks forming part of these indices collectively seem attractive. The price to book values of the BSE-Midcap and BSE-Smallcap indices stand at about 0.67 and 1 times respectively. These are much lower than their long term averages and attractive when gauged in isolation as well. 

Considering the last five year period was one of the most challenging phases for companies, it would be relatively easy to identify the ones that have done well or those that have done much better than their peers. Investors would do well to identify such companies for investment opportunities, especially considering that the markets are not seemingly expensive at the moment. 

Do you think that property prices will come down only when corruption from the real estate sector is eliminated? Let me know your comments

New highs 2008 and 2013 what was there and whats here

Something strange is happening in the Indian stock markets these days. The markets are flirting with new highs, close to the levels seen in 2008. Unfortunately, there is nothing more to the nostalgia. In 2008, the gain in the markets was supported by high growth in the Indian economy. At an enviable growth rate of around 9%, the economic growth rate was around all time high. India then had a strong claim to become Asian power house and seemed like a safe bet for an investment. Coming back to the present, disconnect between the Indian economy and Sensex could not be starker. The GDP growth rate is crawling at around 5%. Even as there is hardly any optimism about the future prospects of the economy; the markets are touching new highs. Ironically, the driving force behind the rally is also one of the key concerns in the Indian economy. The weakness in the domestic currency and hence the benefits accruing to Indian exporters is a key factor that has pulled foreign money t o the stock markets. This is obvious from the fact that stocks of the companies whose business is linked to Indian economy is languishing in the red while stocks in the sectors such as IT and pharma are finding huge favour. 

However, the rally that is unlikely to last long. The first factor that will have an immediate impact will be Fed tapering. Indian economy is already out of favour as far as macroeconomic environment is concerned. There is hardly any internal catalyst with regards to reforms. Hence, it is just a matter of time when Sensex will start reflecting the ground realities. As such, the investors should not get carried away by the current trends and invest only in the stocks with robust fundamentals and attractive valuations.

Asset quality at PSU Banks

The asset quality of public sector banks (PSUs) has been deteriorating assets (NPAs) are steadily increasing. Unscrupulous lending and concentration of loans to big borrowers is the primary reason for increasing slippages. Recently, the All India Bank Employee's Association (AIBEA) released the list of top 50 defaulters who have not repaid their bank loans. Collectively, they owe about Rs 405 bn to the PSU banks (except SBI). Vijay Mallya's Kingfisher Airlines tops the list with a sum of Rs 26.7 bn. It is followed by Winsome Diamond and others as can be seen in today's chart. 

The most worrying factor about rising NPAs in PSU banks is that they have increased due to weak credit administration and not due to financial crunch resulting from global crisis. These are ominous signs for PSU banks. It indicates that their lending practices were inadequate and proper credit checks were not conducted before loaning out money. But the steps taken by these banks once slippages have occurred are even more worrying. Most banks are undertaking write offs rather than indulging in loan recovery. This indicates laxity in efforts on their behalf to recover money. 

The warry road ahead

In FY13, India's fiscal deficit was at 4.8% of GDP. And the finance minister has given assurance that in FY14, the government will be able to rein in the deficit through various austerity measures. However, considering the huge subsidy bill and falling tax receipts reining in the deficit appears difficult. Yet the government is confident of doing it without even raising its borrowing programme. 

Now, the primary reason for cause of increasing fiscal deficit is subsidy burden. And fuel subsidy is one of them. So, the obvious way to conceal the actual deficit number is to manage fuel subsidies. In the past, the government resorted to rampant issuing of special securities called oil bonds to oil marketing companies (OMCs). This was to ensure that the burden does not reflect on its own balance sheet. Although the practice has been discontinued and the PSU oil companies are now paid in cash, the oil bonds still appear in the balance sheets of OMCs suggesting that Government still has a huge liability to take care of. 

Further, seems like the practice of camouflaging subsidies is here to stay. It is not just oil bonds but several other 'special securities' that have helped the government book up the fiscal deficit number until recently. As per an article on Firstpost, currently special securities worth Rs 2 trillion are outstanding! 

Rest assured that oil bonds are not the only culprits. Let us now look at how fertilizer subsidy is being managed through special arrangements. In order to fund fertilizer subsidies, the government makes an arrangement with PSU banks. These banks make payment to fertilizer companies for subsidies that are due. On a later date, government makes the payment to PSU banks. This effectively means that PSU banks are financing the fertilizer subsidy! Yet another example relating to off balance sheet funding. 

We wonder what kind of arrangement government is likely to make in order to finance huge food subsidy burden post the enactment of the Food Security Bill. 

It is therefore evident that the special securities have allowed the government to rein the deficit within its targeted number. Actual deficit though is much higher. Such arrangements may keep India's economic data temporarily healthy. But it is only a matter of time before our vulnerability becomes evident. Investors therefore have every reason to be circumspect of the veracity of economic data, both global and domestic, and keep their portfolio resilient to the worst case scenario. 

Do you believe India's fiscal deficit numbers are authentic? Let me know your comments

Some news for retail investors

Retail investors have been pulling out of the Indian stock markets. Is it only because of the subdued economic condition that has impacted corporate earnings, and in turn, the stock prices? We believe this is not the only reason. Another major reason for the investors' wariness towards stocks has been due to mistrust of corporates. Investors have lost heavily by investing in companies with poor corporate governance, fraudulent behaviour, corruption, etc. Many promoters are also known to take decisions that may be detrimental to the interests of minority shareholders. 

This seems to have worried the Securities and Exchange Board of India (SEBI). As a result, the market regulator has been trying to tighten norms to bring in more transparency in corporate dealings and to ensure protection of investors against malpractices. Here is one such move that the SEBI seems to be considering. 

As per an article in The Economic Times, companies may now have to seek the approval of shareholders if they plan to divest stake in major subsidiaries. As such, companies may be mandated to disclose the financial performance of their subsidiaries, benefits from sale, consideration amount and the names of the parties involved. In addition, the market regulator also plans to mandate companies to disclose their policies on related-party transactions. If such steps are initiated and implemented correctly, we believe it will go a long way in reviving the trust of retail investors. 

Infrastructure Bottlenecks

Ask any well meaning expert the biggest problem that India faces towards its journey to higher growth. 9 times out of 10, they are likely to use the word infrastructure. Indeed, it is the sorry state of the infrastructure in the country that is not allowing us to become more productive. However, it has recently come to light that infrastructure is affecting country's growth prospects in an indirect manner too. In fact, the damage here could be as large as its direct repercussions on the economy. LiveMint reports how NPA crises that most PSU banks in India face are a result of the collapse of the infrastructure boom of the past decade. 

Clearly, no other sector has hurt the finances of the banking industry as much as the bad loans from the infra space. Agreed that on account of delays, a lot of infra projects find themselves with no revenue generation options. However, there is too much concentration of loans among just a few large firms. Besides, the banks most affected have mostly been PSU banks. This raises doubts about the existence of under hand deals and palm greasing in disbursing infra loans. Having said that, the importance of infrastructure development cannot be emphasised enough. And therefore, an effective lending mechanism for the sector will have to be given a serious thought. However, any mechanism will not be able to stay profitable unless Government eases up bottle necks to infra development.