The Volts are gonna move

In the last two months the Indian Indices have underperformed the global exchanges. When Dow and FTSE have returned more than 8% in the last one month, Nifty has just crawled by 2.4%. The up move was grindingly slow, sans volatility. Typically, markets have good swings pre and post earnings. This earnings season (.ie June – July for Q1) was quite against the normal. Surprising again, given the fact that the earnings have not been spectacular. Infact many Nifty 50 companies missed street expectations and yet no major movements in the markets.

In the past six months Nifty has been caught in a tight range from 4800 to 5300. The range has just got narrowed to 5200 to 5400 and now seems to be caught in a much smaller range of 5400 – 5500. Thanks to the slowing down, the Volatility Index (VIX) has come down to 17.3, the lowest level, since its inception from March 2007 (see chart below). Option prices are so depressed even the shorters risk reward ratio is just not worth it.

(The left axis represents The VIX and the right axis represents the Nifty)

While it does seem that traders and operators are having a very bad time unable to move anything, there is a different picture emerging in the FII(Foreign Institutions) and DII(Domestic Institutions) trade statistics. In the past 2 months FII's have bought a net of Rs.18,000 crores($4.5 Bn) worth stocks while DII's have sold close to 12,000 crores($2.5 Bn) net.

(The left axis represents amount is Rs. Crores of Buy /Sell and the right axis represents Nifty)

As can be seen from the Buy sell statistics, Domestic institutions are just not comfortable with the valuations, but FII's are loving India. While the love is purely business, I am not sure what their positions are on the Derivative segment (Believe its Short:P)

At a time when earnings have not kept pace with expectations, we are hitting 52 week highs and on a forward PE basis we are the costliest among major developed and emerging markets. Even China is about 2x lower than us. (India at about 16x-17x and China about 14x-15x). The Global scenario is also not great, with doubts of Double Dip and Sovereign Debt/Credit Risk still looming large.

So all you traders pick up your positions before the Volts start moving, I believe there is a nice little BIG short, just round the corner.

-Vishnu

For all you bulls – I do believe in the long term growth story of India, but for Gods sake let the bears have some fun.

Have Nots to Have: What Regulators can do

Last week Maruti released its Apr’10 – Jun’ 10 results. The street was expecting a profit of +20% and when the results came out the stock tanked 12%. The profit for the quarter was -20%. Reason, the company took a royalty hit of 5+% on Sales compared to 3% earlier.

The RBI recently removed a cap on royalty for transfer of technologies. An Indian company can now pay more royalty (as a % of sales) which was earlier capped at a certain % on sales. Suzuki is the major shareholder in Maruti with about 54% holding in the company and post the removal cap they are charging more on transfer on technology. (K series engines – the Ad were you see a guy runs faster than the train)

Certain policy changes need not be tabled on board meetings and hence are not disclosed. Such policy changes, in my opinion are material and should have been notified. Had Maruti disclosed its intentions, it would have been much easier both for the Analysts who recommend stocks and to the investors to make an informed decision. Agreed, there will be a fall in the stock price had the company announced then, but more importantly -

- The fall wouldn’t have been ferocious as there would be no expectation built in the stock. As in the current case, clubbing it with the quarterly results, there was an expectation built and not having met, the stock got hammered.

- Information dissemination would have been quicker and everybody would have got an equal chance to sell their scrips. In the current case RBI changed its policy in Nov 2009 and I wont be grossly wrong if one were to say that the Mgmt would have decided the change in royalty policy atleast a couple of months ago. The greater the timegap between a policy change and its announcement, the greater the joy for insiders and punters.

Had there been a regulatory requirement stating that “Any contract or change in company policy affecting profits of say x% (say 5%) or affecting sales of x% of the most recent year, the company should inform the exchange” – the blog article wouldn’t have come up.

Some of the things which comes to mind that India needs to work on are-

- Every company must have a website (many don’t) and an investor section. The section should contain past results and also any materials that could be useful for an investor to understand the business better. When the results are announced it should immeditaly be accessible from the website. In many cases results are uploaded a day later the official release from the exchanges.

- It should be mandatory for every company to announce new contracts / cancellation both being above a certain % of sales(many already do, but it should be done by everybody). Report every change in policy which is material say 5% or x% of profits or sales (the one I discussed above).

- Releasing Cash flow statement(CFS) and Balance Sheet(BS) in Quarterly releases. Currently companies just need to report the Income statement of a company, accompanied by a standard set of disclosures. There is no requirement to present the CFS and BS. Its very difficult to know whether a company is making cash profits or has piled on huge debt. If one were to dig, there would be umpteen number of cases where rising sales and profits has not really got converted into cash and a couple of years later it either been written off and in some cases has led to the company going bankrupt.

- Companies should have a Management Discussion and Analysis section in its quarterly results. While many company’s do it once a year, times are changing so fast that people need to be aware of things on a quarterly basis. The management should discuss the broad industry & company outlook and what strategy it is adopting on a macro level. They should also discuss the operational numbers, what led to the increase, decrease for all major line items. Numbers are there because of the business, getting it from the Horse’s mouth gives much more clarity than analyzing ourselves.

- Releasing results pre or post market hours. Many companies release results during market hours this causes huge volatility in the stock prices. Its very difficult for anybody to analyze the results in less than 5 mins, by which time the stock reacts heavily. There could be cases were the profits are down heavily, but on closer inspection there could be a one time charge which if adjusted would meet expectations. By the time this information is cracked the stock would have seen a atleast 3-5% swing eitherways trapping traders and investors on the wrong foot. (Maruti releases results post market hours – not everyone).

- Many companies conduct conference calls with Analysts of Ibanks. The management makes a presentation of the results, followed by Analysts questions. Access to this us available for institutions, but not for the common investors. Company’s should atleast provide “listen only mode” access to investors and a transcript of the meetings.

Retail participation has grown multifold in the past 10 years and will be on the rise in the years to come. Unfortunately Information asymmetry still prevails and it’s a question of Information “Have” or “Have nots”. While the divide will always remain, it just a question of how can the gap be reduced. Its time that the regulatory authorities take a look at the best practices and start implementing them for the common benefit.

CO2 to Cement - Will Calera's dream come true..

In the midst of a lot of hooplah on Climate change, Carbon emissions, blah blah(US), blah blah (Kyoto Protocol), Calera seems to be doing some silent revolution.

What Calera aims to do is to use CO2 and other green house gases(the so called pollutants) to make carbonates or CO3,which then go to produce cement. Calera's process seems to be carbon neutral as they capture CO2 and permanently lock it up in building materials. Some of the largest CO2 polluting industries are Electricity plants both coal and gas fired, cement, iron and steel production.etc., Calera's process could be used in all these industries and have zero CO2 emissions, also produce cement along. To illustrate,- for every ton of electricity produced using coal, 2.5 tons of CO2 is emitted and this process will capture it and produce 5 tonnes of cement. Well it would replace the need for limestone mining.

Calera has already tested this technology in smaller scales with an electricity plant in US and is doing a similar project in Aussieland. Large scale implementation will be the key to answer questions on its viability for mass replication.

The process claimed to be cost effective(without any subsidies the western world enjoys) if proven, could easily be used in both India and China(Hope not too much is charged for the patents). Coal fired plants dominate electricity production in both the countries and this source of energy is here to stay for atleast a couple of decades. Just a small computation would sure say how much of CO2 is going to be emitted - Calera could save us.(not doing the math - but its sure big)

Well there is an Indian connection to this ! Green investor Vinod Khosla has invested $50M through his venture capital firm "Khosla Ventures". Also "Peabody" the world’s largest private-sector coal company is investing $15M in this venture.(Vested interest)

Good for the world as lesser CO2 is out in the open, but not good enough as we are still burning fossil fuels. Hope this is just the start of a chain of GREEN inventions, for there is a dire need now. As always said - "Necessity is the mother of Invention".

- Vishnu

Recently KKR invested 750 Crores(INR)in Dalmia cement, did they ever consider the risk of this technology spreading like mobile telephony - sure to doom the traditional cement companies if it does.

KKR is Kohlberg Kravis Roberts - a global private equity firm and not Kolkata Knight Riders. :-)

RIL's Value Creation Cycle

Reliance Industries(RIL) rained Diwali gifts with bonus shares in late 2009, after a hiatus of almost 12 years. Mukesh Ambani, the chairman of RIL said in a statement that its customary to reward its investors at the end of a value creation cycle. RIL has now entered the next value creation cycle and is seeking growth opportunities within India and globally.

Right from then, the company has been on an acquisitive mode. After its failed attempts to buy out Lyondell Basel and Value Creation, RIL had finally zeroed in on Atlas Energy. Though broadly within the energy space, all the above companies had different businesses. Lyondell was a bankrupt global Petrochemicals company, Value creation - focusing on Canadian Oil sands and Atlas Energy – A US shale natural gas producer. Looks like RIL had scanned a wide array of investment options.

In its recent deal, RIL has acquired 40% stake in Atlas Energy’s Marcellus shale assets for $1.7 billion. The cost of acquisition will involve an outright payment of $340 million and $1.36 billion spread over 5 ½ years. RIL expects the total investment in the assets to be around $5 billion. The deal gives 120,000 net acres in Atlas’s Marcellus Shale acreage, the biggest and one of the promising shale gas fields in the US. The shale is characterized by low cost extraction and its proximity to the North east gas markets.

What is Shale Gas : Shale gas is natural gas extracted from sedimentary rocks, having very low permeability. Shale gas is considered to be unconventional resource due to its extraction techniques. Conventional resources, involve drilling of vertical wells into reservoirs, the minerals seep into the well enabling easier extraction, just like a water well. Shale gas extraction is much more complex as there is no seepage because of the rocks very low permeability. New techniques like horizontal drilling, hydraulic fracturing has made the extraction process easier and cost effective.

US Gas Demand / Supply & Pricing: Conventional natural gas production in the US has been on the decline curve and it was widely expected that Liquefied natural gas (LNG) from middle east will fill the supply shortfall. To benefit from demand – supply mismatch, many companies in US started investing heavily in unconventional resources. The frenetic pace led to technological advancements, which has brought down the cost of extracting shale gas, earlier considered uneconomical. But all is not gung-ho, as more and more companies jumped on the bandwagon, supply over ran demand and now US seems to have more gas than ever.

Same is the case on the pricing front, back in July ‘08 when oil was at $140 /bbl , natural gas was trading at $14/mcf. (Ratio 1:10). Thanks to the recession & the shale boom, the excess supply has brought down the current price to $4 /mcf, while crude is trading at $80 / bbl (Ratio 1:20), almost half its usual spread to crude. While in the near term, excess supply is bound to prevail, companies in the business are hopeful to see a $6 / mcf in the medium term(next 2 to 3 years).

Where is the Value to RIL?: The near term outlook of the US natural gas space is nothing but bleak, so not much expected from an earnings perspective. From an acquisition stand point, RIL’s timing could probably be good if not near perfect, as the company has bought the assets at the lower end of gas prices. It also gives a start for its global foot print and a share of the US natural gas business. “Reliance” for sure will have a better brand recall. But there sure are other take aways - the technology and the technical know-how. But where could these be used ?. INDIA. Our country is believed to holds huge shale deposits across the Gangetic plain, Assam, Gujarat, Rajasthan, and many coastal areas. Unfortunately our exploration policy (NELP) does not covers unconventional resources(shale gas) as of date.

India's gas requirement for FY 10 stands close to 150 mmscmd of which RIL is already producing about 65 mmscmd and will reach a peak plateau of 80. The shortage would be met by LNG, burning India's trade surplus and with it the forex reserves.

Well, things might change in the future. A new format of India's exploration licensing policy called OALP(Open Acreage Licensing Policy) is being worked and unconventional resources could well be exploited under the new regime. RIL's technical knowledge could well be the piecing point in its next real value creation. While, many companies with similar expertise could cash in, RIL for sure has a clear advantage operating in India. You guys know what i am talking about.

If “All Iz Well” a day would come when, India could potentially meet its energy needs domestically and may well turn into a net exporter of gas.

--Vishnu