Friday, October 3, 2008

Are housing prices set to correct ?

  1. Stock price performance

Since, the beginning of the corrective phase in Indian equity markets, real estate stocks till date over the last 9 months have corrected 70-80%. In contrast, property prices (in terms of transactions reported) have more or less been constant or corrected some 10-20% in non prime tier 2/3 cities where there is stark over-supply situation.

A lot of research into the lead indicators of the economy / sectors have given findings that equity markets / prices are lead indicators of the economy. The time taken is a function of efficiency of individual markets. My own observation has been that Indian markets are fairly efficient and do factor in the immediate 9-12 months expectations.

  1. Rental yields

Rental yields in high growth areas in India has traditionally hovered around 3-4% and 2-2.5% at the lower end of the range (periods of exuberance) and around 4.5 -5% (periods of extreme pessimism). If we consider the end of year 2007 as a period of exuberance as also rental yields in quite a few reported transactions then have been at 1.5-2% levels, then a correction of at-least 25-33% looks possible under normal circumstances. How long will this take? nobody knows. 

  1. Affordability

Commentators keep coming up with the logic that the India story is intact, there is huge demand and with any fall in prices…demand will pick up. Let me tell you that human being as investors behave the opposite! So investment demand will fall with falling prices, it might just wither away. 

As for people who are consumers, the demand exists and will continue to exist. But, it will be price sensitive (meaning affordability holds the key)… if we take a typical urban  middle class nuclear family whose average income will vary from anywhere between 3.5-7 lakhs p.a. at a time of rising interest rates will not be more than 4-5 times annual earnings. Neither will banks lend more than this. 

So by definition, house prices in urban areas need be around 14-15lakhs (for small sized properties) and around 30-35lakhs (for mid sized properties). If we consider these prices for 2 cities of Mumbai and Delhi (of which I am aware)…one (rather any one looking for a property in a not so prime residential area) will find that the prices being quoted by builders and brokers are around 20-33% higher than affordability. 

Typical real estate cycles have been around 6-7 years cycles and these have usually been longer than the broad economic cycles. (Financial markets act immediately, real estate markets take time to equilibrate). By this logic, we are around 3.5-4 years into the cycle which started in mid / late 2004. 

I donot know which indicator / argument is more / less predictive, but since all point to a single direction I reckon most people will wait to watch before transacting. 

Tuesday, September 16, 2008

Reasoning market behaviour – think the i-m-possible ?

Beginning January 08 markets the world over and Indian markets in particular have been correcting. What went wrong ?....Common answers (a combination of all and some of the below) 

  1. High oil prices, exerting an upward pressure in input costs…without an ability on part of Cos to right away pass on the costs
  2. Similar to 1 above is high commodity prices
  3. High inflation
  4. Rising interest rates ….(this of course followed from point 3 above)
  5. Massive unwinding in overseas market and the sub prime crisis leading to negative sentiment and a drying up of liquidity
  6. Most also buttressed the above reasons to add that the multiples at which Indian equities were trading were at very high levels though not as high as the dotcom boom or the 1994-95 boom levels.
  7. To further add to the reasoning – it was also suggested that all of the above would lead to a re-pricing of risk and therefore there will be re-adjustment of multiples. 

We are nearly 9 months into the correction? The situation now is as under :- 

  1. Oil prices have fallen more than 1/3 rd from their peak level of nearly $93-95 a barrel
  2. Commodity prices are cooling …except for agri commodities…where too I feel a supply side response is on its way…since it usually takes 2-3 years for cropping patterns to changes and efficiencies to show results
  3. Interest rates – most will agree are peaking …also in a globalised India…..India’s interest rates (exchange rate on the other side) cannot behave out of tandem with the rest of the world over a prolonged period
  4. Sub prime crisis losses can reasonably be estimated …some may not agree to this…but to my mind what can be estimated with reasonable certainty in an acceptable range (the narrower the better) is what the market looks for and operates on
  5. Most of the unwinding pursuant to point 3 has happened or the direction and the timing when it will be done is known
  6. Multiples in Indian markets have corrected by more than 35% (as measured by leading indices) and are now at similar / lower levels with what has been a median / average range over the last 15-20 years
  7. Re-pricing of risk -  this is arbitrary, but historically (as per various research papers and surveys) equity risk premium has been in the range of 5-7% …even if we add another 2% on account of high interest rate (to account for an increase in the risk free rate) and another 3% for the so called re-pricing as predicted in point 7 above…the cost of equity would be not more than 20%....Return on equity of the top 50/100 companies in Indian markets would very easily meet this criterion. 

But, I am yet to come across one commenter who now say that the markets are on their way of recovery. Most people who come on business channels / media would say the worst is yet to come ? we will wait for Q3 / Q4 etc results to take a view… does the US and the EU economies / markets behave etc….despite the fact that none of the reasons given by them earlier for the market fall do actually in full exist or it they do…then too the effect is waning. 

My own reading is as follows:- 

Five years of positive loop working (the bull market of 02-07- some still say this is on!) had built excesses in the real economy  (housing prices, food prices, metal prices etc). 

All will not correct overnight …some of it may get carried forward over longer periods…but there will certainly be calliberation…and mind you – this can be very violent as is being evidenced 

It has taken probably the 2-3 years to build the excesses…so evening out should take at least another year or more! this now is what is projected as a negative loop. 

If equity markets on an average over long periods to time (10-15 years or more) have provided 15-18% returns. …and the last 5 years have provided more than 30% returns ….the next few years will certainly compensate for the moving away from the average. 

Is this the negative loop or a natural calliberation? – choose your tag!

Friday, June 20, 2008

Bangalore's Builder Cartel - The city's developers are rewriting Economics

This is from a post in the Business Today (29/06/08) page 48
"Prices of a product fall if demand for it eases is what is conventional economics. But Bangalore's real estate market will defy that logic. Recent market surveys reveal that the demand has, by and large slackened, but all leading developers of the city have come together to pep market up by deciding to hike the price of their products. The price will go up between Rs 75 and Rs 500 per square foot, depending on the size of the flat." - the Karnataka Chapter of Confederation of Real Estate Developers Association of India (CREDAI) a real estate lobby has made an announcement to this effect.
When asked whether this was a cartel in the making ?
The reply was 'a cartel is one that cuts supply when the demand is robust. But, we are not limiting supply at all also we neither control individual members'
My understanding is that real estate demand beyond a point is not price elastic and if all is available at 'a jacked up' price what option does the buyer have ? What happens to the argument of free markets which all builders advocate when it comes to regulatory intervention in thier so called development projects etc ?
'Basic living facilities-real estate ' should this not be on par with essential commodities and even if not a part of it why should the state allow cartelisation ?
Despite formal reporting of such news, inaction on part of the regulatory bodies is frustrating. If the govt / citizen's group donot bother to set this right, markets am sure will take its own course over a period of time to ensure the bubble bursts (cartel are broken) but, that will surely be violent - hurting all, not just the culprits

Wednesday, March 12, 2008

Company(s) name change (first tech, then infrastructure!)

Change of name (subject to availability of that name) of a Company requires a board motion to be approved by shareholders by special resolution (more than 74% in value of those members present and voting at the meeting should approve it, since this involves amendment to the name clause of the memorandum of association of the Company).

In case of listed companies this rule is no different except that the stock exchanges will need to be kept posted on the resolution and accordingly be informed to make the changes to the name of the Company and its ticker symbol as and when it is effected.

Listed Companies in India on an average have around 45-50% as promoter holding, with around 20% being held by FII’s and close to 5-10% by domestic institutions. Add to this the holding of HNI’s and you will realize that nothing can prevent a small group (in number) of shareholders to pass a special resolution should the promoters decide to go ahead with it.

By necessary implication the name of a Company should ideally be reflective / or is perceived to be reflective of the principal activity in which the Company is engaged in.

During the tech boom of 2000. Many Companies had their names changed prior to accessing the public markets (launching an IPO), this was done essentially to
Command higher valuations, Tech companies in those days used to trade at as high as 3 digit multiples
Create a buzz around the issue and thereby ensure subscription.

The Indian regulator after the party was over and damage done, introduced the following provisions in the DIP guidelines by circular no 11 dated 14-08-2003 (regulations for unlisted companies accessing public markets)
“In case the company has changed its name within the last one year, at least 50% of the revenue for the preceding 1 full year is earned by the Company from the activity suggested by the new name”
Since, the above rule applies to unlisted companies going for IPO’s. What about companies listed going for IPO’s or even other wise not accessing the public markets but going for a change of name to change the perception of the market participants about its business (meaning improve valuation multiples)? The answer - there are no rules in place to check them. Recently, to name a few well known companies have changed their names e.g.
Diamond Cables (is now renamed as) = Diamond Power Infrastructure
Reliance Energy (is now renamed as) = Reliance Infrastructure

Though with shareholder approval it is the right of every company to have its name changed in order to be reflective of the nature of activity it is getting itself into. My simple submission is that since I believe that reputation cannot be built on future projections, why is it that till such time the activity as reflective by changed name does not constitute a dominant activity it (Company) is not required to make adequate disclosures in respect thereof. In my view, the disclosure may be simple that the changed name should be affixed to the existing name and no changes to the website address or email addresses be allowed in the interim. Any other manner in which this can be achieved is also acceptable.

My question - Are the regulators waiting for the damage to happen and then create a regulation around it with the bad memories as a base?

Monday, March 3, 2008

Warren Buffet's annual letter to shareholders

I wait for a year to read this and now I have it.
the link -
Will post my comments to express gratitude later

Thursday, February 21, 2008

Is all Income Value Accretive ?

In equity markets, when evaluating businesses, whether an investment is sought to be made through an IPO / secondary market or private equity investments (PIPE deals / unlisted Co's), to my mind any prudent investment manager / investor evaluating Company financials, profile and the business model would seek answers to two principle questions
1. How big can this become (scalability) ?
2. How sustainable will this be (returns on capital employed) ?
It therefore follows that one would make an assessment of value of business on sustainable profits / turnover / cashflows & at what Internal rate of return (IRR) the cash flows are again likely to be re-invested (right scaling up of business!).
What can be sustained ? Only that which adds value and is something which would survive by natural selection i.e. fit to withstand competition and grow. This is then a quality test and not a quantum test (which i presume models would not capture, since this is not binary but will put to use one's experience and judgement).
Across all media valuation multiples are reported using total earnings i.e. the earnings no does not even provide for a simple differentiation between earnings from regular business activities and earnings attributable to other income. It is without dispute clear to me that media cannot be expected to provide sustainability calls on earnings but, atleast a better earnings no can be reported.
The last quarter ended Dec 07 results earning per share growth has almost entirely been on account of increases in other income, which to my mind go straight to the bottomline (one may check CMIE data or broker aggregate results updates for the top 100 cos or so), thereby inflating the earnings no (EPS) and consequently lowering the valuation multiples (making things look cheaper or rather less expensive than they are !!!
Rising other incomes is a cause of concern. The concern is - are companies booking profits on some of its investments to show / maintain profit growth or deploying surplus cash on its balance sheet in the equity markets / banking system to generate higher income. In the former case, it is an indication of a slowdown in earnings which the Company does not want to acknowledge and the latter indicates that the Company does not have avenues to deploy additional cash thereby affecting the IRR at which cashflows are invested & consequently the sustainibility of current earnings. Beyond a certain level, this is also a corporate goverance issue.

Tuesday, February 19, 2008

How do exemptions or incentives become loopholes ?

One permanent feature of laws - Various small loopholes are sought to be plugged, huge glaring loopholes are left untouched.
Let me draw an analogy to taxation laws to explain. Over the years we have seen politicians and film stars becoming owners of poultry farms, hotels, software and other export firms, and agricultural land depending on the scope for laundering unaccounted income at minimum cost in the form of payment of taxes. (In markets - black and/or illegal money being routed through multiple sub-account registrations, p-notes etc)
Even today agricultural income is left untaxed (markets - companies doing pre-ipo placements at with institutions / FII generally at lower valuations) which is the reason why film stars, politicians are keen to acquire such land. I am sure our politicians must have acquired construction firms and multiplexes, to take advantage of the tax holidays for laundering their ill gotten gains.
One would argue that these exemptions are meant to incentivise certain types of economic activity and are not really loopholes. Most politicians or persons interested in laundering their money donot have the patience or the inclination to really carry out the concerned activity, and merely create paperwork to show such activity is being carried on, though it is not really so. The loop hole is therefore created due to inadequate verification of facts. A proper inquiry will certainly throw up the correct facts but unfortunately for obvious reasons, the will is often lacking. I however, continue to believe that good rules are bad substitutes for character.
I recollect having heard Mr.Nani Palkhiwala (one of this last few sessions on the budget which I had a chance to be part of) - "Bad economics may temporarily be good politics; but politics should be behind a fiscal law, and not in front of it."

Monday, February 18, 2008

Executive Summary (as part of the prospectus filed with SEBI for IPO/FPO/Rights/Takeover-Merger document)

A typical prospectus filed with SEBI would be around 250-300 pages minimum. The very reason it is filled is to provide investors with full disclosure on the Co making the offering. With around 2-3 IPO's/FPO's every fortnight (that has been the trend every month over the last 2 years) going through each prospectus is very difficult for a retail investors (especially those not having finance background...and what about junta who donot know English....should we not have a hindi version atleast....may be not Gujrathi !).
I just wonder why can SEBI not insist on having an Executive Summary (3-4 pages) as part of the prospectus, which can just include relevent & important information which is already covered in the whole document. Currently, brokers make a synopsis 3-4 page reports with thier recommendations and provide thier views...(i wonder each house has its own opinion based on analysis...nothing wrong with this....but why should a layman who would want an independent executive summary of the offering not have it in 3-4 pages but be required to read through the whole document or refer to broker reports...assuming he has access to them!)
What is to be included and not included in the executive summary can be rule the same manner the rest of the document (prospectus) operates...useful references to pages can also be provided if someone wants to look at sure a software & a reader to correct the results can handle this.

Monday, February 11, 2008

To start with

I remember Mahatma Gandhi saying in his book "My experiments with truth"

'One cannot do right in one area of life whilst he is occupied in doing wrong in another; life is one indivisible whole.'

I reckon this point of wisdom is profound. A commitment to excellance is not just reserved for a few select areas of our life - it must be reflected in everything we do. Our diet must reflect our commitment to excellance. Our personal habits must reflect our commitment to excellance and our thoughts must reflect our commitment to excellance.

May I be able to extend this commitment to this blog.