Sunday, January 1, 2012

Seas of concern and Mounts of hope

As we begin the new year, it may be useful to step back and take a look where we stand in terms of what was actually wrong with the year gone by. Most commentators seem rather relieved to have got rid of that 2011. When we say wrong, reference is not to the numerology of 2011, but the scars the year left on all stock indices – main index, sector indices, mid cap, small cap – whatever you pick is down by anything from 20% to 40%.
I came across a report recently that condensed the concerns as 11 “C"s, which pretty much sums up the challenges. In this post, we call it the seas (“C”s) of concern.  I discuss some of these and my current take on each one of the factors briefly, with the usual right to be wrong.
C1 - Central bank tightening:  RBI hiked policy rates taking the interest rate in the system to multi-year high, and in the process, successfully “killed” growth without tackling inflation. Monetary policy tools could not have filled up for government inaction in addressing fiscal ills. It is natural to expect that interest rate hike cycle will now reverse in 2012.

 C2 - Crisis in Europe: Euro problem is not resolved by any means. In context of India Inc, impact of Eurozone crisis manifests itself in 3 forms - companies having (a) direct customers or business in Europe (b) shareholding of promoters, or FIIs out of Eurozone, who may be affected by Euro situation (c) subsidiaries in Europe. For other companies, there may be no fundamental roots in the crisis so impact, if any, is largely sentimental. I hold the same view for 2012 if our company is linked through any of these.

 C3 - Corruption scandals occupy headlines: More than directly impacting the business, such issues have negative effect on investor sentiment. The way things are developing we will see more of this dampening 2012 as well.

 C4 - Costs rise faster than revenues:  Corporate earnings hurt as margins drop. Raw material prices continuing at the same elevated levels are not going to be reversed, though their increase in percentage terms compared to last year will flatten out in 2012. Added to this is the increase in fixed costs which take time to spread over volume growth. In this context, it is important to note that only those businesses with moderate to high pricing power might be in a position to pass on the cost increase, for the rest it will surely hurt the earnings trajectory.

C5 - Compression in multiples: This is interesting since I like to analyse the historical valuation multiples that markets accord to a stock. Cut in earnings and growth is like a double-edged sword since it impacts both earnings and PE multiples. At a fundamental level, we discussed before some of these aspects here. It is this double blow due to which we have seen prices becoming half for so many stocks in last 6 months.

C6 - Cold Storage for policy action: Enough has been said in the media on this aspect and I won’t be adding any value by elaborating on it. Post state level elections, may be, we will see some concrete action on economic reforms agenda in fiscal 2012-13 which can have mildly positive effect for markets.

C7- Cost of living rises: Inflation proves too stubborn and economic fall-out of this leads to lower discretionary spends, well relatively speaking. When we say inflation, I’m not referring to government figures, but the reality of price rise at the ground that hits actual surplus available to common junta. Consumer looking to prune his budget spending will first look to cut out on non-essentials luxury items, and somebody has to lose out in the process.

C8 - Consumer stocks outperform: You must be thinking why this is included in the sea of concerns. Issue is lot of smart money is hiding in the “safety” of consumer stocks in the recent fall, which has prevented correction in their valuation that was otherwise warranted given increase in material costs and slowdown in projected growth rates. It is anybody’s guess if some correction can happen in this theme during the current calendar year.

C9 - Currency slides to all time lows: This has effected more companies than market had thought initially in ways more than one – (a) Forex borrowings by way of FCCB, ECB, bilateral etc. (b) Imported raw materials (c) Hedges taken at higher rates of rupee (d) Selling products domestically which are denominated in USD, partly covered in (b). We have not discussed commodity prices here but interplay of cyclical variables is going to be important going forward. With weakness in rupee persisting, this would linger on in the new year.

C10 - Capex tumbles:  Investment climate has sort of collapsed in the wake of high borrowing costs, issues of coal supplies, iron ore mining, environmental clearances, slowdown in release of orders, telecom issues & legalities. Just recall the time it took for Vedanta – Cairns approval. On a sidenote, in the M&A space, some of the previous overseas acquisitions of India Inc have not done that well which does not help the story either. 2012 can see improvement from where we are and then it will be down to the company specifics.

 C11 - Corporate confidence shaken: To me, this is probably the most worrisome of the lot. It takes time for an entrepreneur to start making fresh commitments & investments in a grim scenario.

It looks to be another rough year ahead with all these contributory factors staring at us. I don’t understand how experts are reeling out their picks & targets for 2012 as if Mr Market works by calendar. This brings us to the mounts of hope. One hopes some of the feel-good factor comes back in corporate circles, at least by second half of next fiscal, if not earlier.

Macro-economic scene is not in our hand but what choices we make certainly are.

Best wishes for a great new year, have a peaceful & prosperous 2012!

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