Category: Markets

How the levy of Import Duties can help MSMEs in 2018 (The less obvious reasons)

In late 2017 after a long wait green shoots have appeared in stock market earnings, giving hope that current high market valuations may finally be sustainable. The bad news is that 2018 brings with it an expectation of an increase in crude and other commodity prices key for Indian Industry.

This is very bad timing for the economy, particularly small industry which is already reeling from demonetization and GST and is very sensitive to raw material prices.

Among finished goods listed above, the Government of India has also recently imposed duties on steel and cooking oil. I am not sure if these protectionist moves can be termed as a case of central planning overreach or a timely intervention but there are both obvious and less obvious reasons to why a levy of import duties now is critical to protecting small companies.

Globalization as a cause of NPAs

This is a controversial statement but if crime is looked through the lens of intent Essar, Jindal and Bushan Steel did not intend to default on their loans. In other words, manslaughter is not murder. They were not guilty of causing NPAs.

Capacities were being built by these steel makers with the intent to expand business – easy access to loans was just a covenience they enjoyed thanks to political patronage and poor lending controls at banks.

Then the slowdown in steel prices happened. A duty on steel at that point in time may have helped insulate industry and banks. But Chinese steel was dumped in India impacting the turnover of the companies and making them non-viable. The capacities these companies built gathered rust and banks that had financed them took an enormous hit on asset quality.

Credit Situation for MSMEs is tight

A result of the NPA situation is banks are not in a position to lend or are not willing to lend to MSMEs. This raises the cost of capital for MSMEs who must rely on internal accruals to finance growth. Internal accruals in turn depend on their margins which will be under pressure if 2018 sees a major uptick in commodity price inflation.

Operating Leverage is a Necessary but not Sufficient condition for MSMEs to thrive

Lets admit that most MSMEs are involved in downstream value chain activities and commodity businesses. This in turn means their margins are low and are highly dependent on raw material prices as they have little pricing power with their buyers and little bargaining power with their suppliers.

Operating Leverage is one key competitive advantage they can hope to build in their commodity businesses but a major percentage of their costs is still variable.

To give an example – Plastiblends (NSE: PLASTIBLEN), which advertises itself as India’s largest manufacturer and exporter of Colour & Additive Master Batches and Thermoplastic Compounds for the Plastic Processing Industry has 80% of its cost structure as variable costs – its margin being highly dependent on the price of crude. Plastiblends has the highest economies of scale of any plastic master-batch manufacturer in India and even then it has a huge sensitivity to raw material prices.

In a scalable business the average cost of creating the products and/or services fall as the volume of its output increases.

But in the case of rising commodity prices, Operating Leverage will not be very useful for such companies as each additional unit produced will cause an increase in average costs, irrespective of capacities at hand. (Even if somehow they can borrow at reasonable cost of capital from the reluctant banks to build sufficient capacities).

Since smaller MSMEs cannot retain their margins in the face of increased raw material prices they will not be able to transition to becoming larger players like Plastiblends, or even worse, will not be able to survive. This is obviously a very bad scenario for Indian MSMEs and the job market.

Final Thoughts

ROIC or Return on Invested Capital is a degree of attractiveness of a business. ROIC is described as the operating margin multiplied by asset turnover. In other words, the two components that define a company’s fitness are the ability to charge a high spread between price and actual cost, and the ability to generate sales from a small base of invested capital. Import Duty helps protect ROIC of MSMEs by removing competition from cheap import substitution, so if the spread cannot be maintained in a scenario of raw material inflation Рthe sales of MSMEs atleast can be sustained.

Alibaba didn’t grow in a vacuum, neither did Maruti Suzuki. Government protectionism helps create large home grown industries but for MSMEs under Make in India it may well be a matter of survival.

Taneja Aerospace. Looking Bullish on the Charts?

I am new to Technical Analysis and this post is not a BUY/SELL recommendation.

I recently wrote on how the announcement of the Hosur airport might be an inflection point for TAAL (NSE: TANEJAERO) in way of monetizing its fixed assets.

Taneja is a very speculative scrip because there is not much information from fundamentals (low EPS, slow moving industry), so in this post I delve into some technical charts to see if Price and Volume behavior could give me more information on how the market is reacting to the news.

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1 year Candlestick and MACD charts

Here’s a copypasta from Investopedia on how to use the MACD.

The concept behind the¬†MACD¬†is fairly straightforward. Essentially, it calculates the difference between an instrument’s 26-day and 12-day¬†exponential moving averages¬†(EMA). Of the two¬†moving averages¬†that make up the MACD, the 12-day EMA is obviously the faster one, while the 26-day is slower.

Look how the 12-day EMA rises above 26-day EMA after a long subdued period on March 30, 2017. What happened on this day?

March 30 was the day when the Indian Central Government announced routes assigned to 5 regional airlines under the low-cost UDAAN scheme. One of them is TruJet that plans to use the Hosur Airstrip for regional flights to Chennai. For more details read the¬†analysis of this announcement’s significance.

Let’s zoom in a bit.

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You can see how the news was priced in after 31st March and the short term trend became Bullish as the blue line (short term Exponential Moving Average) increasingly diverged from the long term Red line.

Stocks react to news all the time. Why is this significant to a fundamental analyst like me, you may ask?

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The above is a 5 year chart of weekly volumes in Taneja Aerospace. You will see the highest 5 year weekly volume was during the week of April 10, 2017 after a brief lull period.

It may be safe to assume this unprecedented surge in volumes in response to the news that broke on March 30, 3017 which has significant ramifications for TAAL which operates the Hosur airstrip. Let’s break this week down a bit more to examine what’s been happening under the hood.

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You can see above that the surge in price was supported by the largest weekly volume in 5 years, which was followed by a sell-off – which was probably triggered by HNIs “stuck” in Taneja for a long time and who used this rise in price as an opportunity to offload their “stuck” shares.

Remember the last time Taneja went as high as 68 rupees was 1-year ago in January 2016. Since this is a non-profitable company and a speculative grade stock, its price responds mostly to “news” or “noise” and a lot of folks were stuck at those higher levels in early 2016. So the price range of 65-68 serves as a RESISTANCE zone for Taneja Aerospace’s stock price.

This is indicated by the huge volumes and red candlesticks (selling pressure) whenever the stock hits this resistance price range, even if it is preceded by white candles in prior sessions. See the price action for earlier last week (24 July) for the most recent illustration. High volume buying, following by high volume selling when the stock price hits the resistance zone.

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Piercing Line Reversal after Huge White Candlestick – This sort of price behavior makes this stock a Knife!

So where does it go from here? There were 3 significant candlestick patterns in the recent weekly chart labelled 1, 2, 3 in the image below.

  1. White candle with huge volumes. Like the week of April 11 and June 15 – all surges in price have been accompanied by huge volumes which are usually twice or more than the selling volumes.
  2. Long lower shadow – after selling in the resistance zone, a bullish indicator shows itself on 25th July. Volumes are dropping significantly.
  3. Doji – which shows the fight between bulls and bears is coming to an end. The opening and closing price are nearly the same and the selling pressure has been absorbed.

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Conclusion

The stock has been range bound for a long time. In the short term it seems the price is being kept down artificially by traders and short positions. These traders sit it out on days of huge volume as seen by the clean white bullish candlesticks. Weak hands and “stuck” HNIs seem to be almost out of this scrip and we may see significant moves in the future once accumulation/distribution is complete.

DISCLAIMER:

This post is not BUY/SELL/HOLD advice but a statement of my personal analysis and opinion. I am not registered with SEBI under SEBI (Research Analysts) Regulations, 2014. As per the clarifications provided by SEBI: ‚ÄúAny person who makes recommendation or offers an opinion concerning securities or public offers only through public media is not required to obtain registration as research analyst under RA Regulations‚ÄĚ.¬†No BUY/SELL/HOLD advice is offered on this blog, in any form whatsoever. Views expressed are my own and not of my employer. Stock Markets are very risky and can cause a permanent loss of capital. You should seek professional advice.

Thoughts on using the Discounted Cash Flow for Small Caps

Interesting lecture by Professor Aswath Damodaran on intrinsic valuation, where he breaks down the use of the Discounted Cash Flow assumptions in some detail:

Interesting how the students approach DCF and seem to collectively conclude one of the Professor’s portfolio stocks (Twitter!) is overvalued by 1000%+.

It appears that in his investment decisions the Professor can take a contrarian position vis-a-vis his own field of study Рwhere he is counted as among the best. A lesson for all the excel snobs amongst us. Stay humble.

Perhaps this is also because – as his lecture amply demonstrates – the DCF calculation has a lot of moving parts. When you have a lot of moving parts, the risk of error in each moving part gets multiplied to give you an overall risk of error with valuation using DCF.

So it helps to keep it simple while doing valuations. Here’s why I stick to a conventional, back of the envelope calculations like the Price Multiple Model to begin with. I wrote about how an investor can use the Price Multiple Model¬†as a first step valuation, and combine it with other models.

Apart from the complexity, there are other problems with using the DCF for small caps:

  • The Small Cap Risk Premium is hard to determine and there is no sure way to know it exists!
  • Small Caps are subject to cyclical risks, which can lead to wrong factor assumptions in valuation
  • It is hard to predict steady returns with young companies
  • Cost of debt can be hard to calculate for Small Caps that are not investment grade or do not have a debt rating assigned to them

In valuing a Small Cap, it helps to understand intangibles first. It is a case-based approach that takes into account promoter quality, market size, competition, input prices, the balance sheet and scuttlebutt among many other factors.

In short Рinvesting in small caps is a little like Venture Capital investing. Numbers are needed for comfort, before you take that leap across the void of permanent Capital Destruction.

After QE, could AI be the next trigger for the Bull Market ?

This post is not buy/sell/hold advice. Please see the disclaimer at the end before reading further

I came across an interesting Accenture study

Artificial Intelligence is expected to drive a new wave of rising productivity, similar to what happened during the Industrial Revolution. In numerous economies, especially developed countries, increases in capital and labor are no longer able to drive decent levels of growth. Artificial Intelligence is seen as a new factor of production that can change the situation by transforming the basis of economic growth.

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Continue reading “After QE, could AI be the next trigger for the Bull Market ?”

The Mood Swings of Mr Market: 3 exhibits from November 2016

Ben Graham, the father of Value Investing was the first to call out the Market’s mood swings, anthropomorphizing the creature we know as Mr. Market.

Mr. Market is emotional, euphoric, moody and often irrational 

This behavior of Mr. Market allows the investor to wait until Mr. Market is in a ‘pessimistic mood’ and offers a¬†discount to fair value.

Continue reading “The Mood Swings of Mr Market: 3 exhibits from November 2016”