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BIG NEWS – Nov 03rd 2017

Posted on 03-Nov-2017 Comments  0

Fed Chairperson

Why global markets will cheer Jerome Powell…

Even as the final announcement on the Fed Chair is still awaited it almost appears to be clear that the job would go to Jerome Powell. While Janet Yellen was in the reckoning for a renewal, it was always unlikely considering her equations with Trump. But the bigger question is, what happens to Fed policy? Will we see a dovish tilt or a more hawkish tilt?

Focus on inflation and jobs…

If the initial sound bites coming from Jerome Powell are any indication then like Yellen his focus is also likely to be on jobs and inflation as a key driver for rate action. The market expectation is that Yellen will hike rates by 25 basis points in December this year. This is likely to be followed by another 75 basis points hike in 2018 after the new Fed chair takes over. But then estimates of the Fed trajectory have been generally wrong and till date Yellen has also preferred to err on the side of caution. Till date we have just had 100 basis points hike in the last 2 years since the rate hike process started. It is highly unlikely that Powell will digress too much from the path adopted by Yellen. Of course, in terms of temperament Jerome Powell is likely to be more of a market dove but then any sharp spike in inflation is unlikely unless oil prices really shoot through the roof. Like in previous years, rate hikes may continue to be cautious with rates trending much lower than the pre-crisis levels.

What about tapering?

What about the bond tapering program that was supposed to be initiated by Yellen. Here again Powell is likely tread with caution. While there will be a phased reduction in the bond portfolio of the Fed, any drastic reduction looks unlikely for 2 reasons. Firstly, Powell will try his level best to keep liquidity situation in the US markets comfortable to sync with Trump’s plans for tax cuts and greater infrastructure spending. Secondly, there is an important global angle to it. After a long time, the EU, UK, Japan and China are beginning to see green-shoots of growth. A growing world economy is good for the US and Powell will not be too keen to upset the apple cart. You can expect Powell to be a lot more calibrated on that front!

But,UK has hiked rates…

We see the rate hike of 25 bps by the Bank of England as a one-off event. That has already been confirmed by the governor of the BOE. The UK will not want to tighten liquidity and push rates higher at a time when UK is trying hard to extricate itself from the pain of BR EXIT. As long as the global consensus leans towards a calibrated rate policy and ample liquidity, the world markets will be sufficiently pleased. That is what it is right now and that is what it is likely to be in the near future. Powell only reinforces the view that the learning will be towards easy money! ©

Airtel Must Worry

Why there appears to be too much froth in the Bharti stock…

It is hard to recollect the last occasion in the previous 9 years when Bharti Airtel appreciated by nearly 35% in a span of less than 1 month. Two news events have driven this move. Firstly, it was the decision to take over the mobile business of Tata Tele. Secondly, the second quarter results were apparently not as bad as expected. But there is a froth building up and investors need to be careful at these price levels!

Big deal on Tata Tele…

The big story on the Tata Tele acquisition was that it comes to Bharti Airtel at no cost. But then, what is the big deal. There is a small portion of the spectrum debt that will come into the books of Bharti,but that would be small by the size of Bharti’s balance sheet. The acquisition will add 4 crore customers to the Bharti stable but then it will come with a much lower ARPU (Average revenue per user). By acquiring 4 crore customers with lower ARPUs, Bharti is only going to depress its average ARPU further. During the same period, the stock price of Tata Tele has doubled and that is perfectly understandable. Tata Tele actually gets rid of its loss making mobile business and can now focus on its enterprise business. But it is hard to fathom how this is likely to incrementally benefit Bharti Airtel. The lower average ARPU will put Bharti at a further disadvantage with respect to its biggest competitor in the market, Reliance Jio.

Results were also disappointing…

To be fair, the net profits of Bharti Airtel actually plummeted by(-76%) during the quarter. The reason was clear pressure from the pricing adopted by Reliance Jio. The results indicate that the Jio effect is beginning to clearly tell on the top-line and the bottom-line of Bharti Airtel. As Reliance continues to embark on its aggressive expansion and customer acquisition program, we are likely to see more of the incremental data revenues accruing to Reliance Jio. The way Jio has disrupted the voice pricing, the future is likely to be all about data. This has forced most of the telcos to offer massive discounts on their data and voice pricing. It is hard to fathom how Bharti is going to make money with this kind of economics.

Lower IUC charges, the last straw

Inter-User Charges (IUC) forms a core source of revenue for Bharti due to it span-India network. Bharti was a big beneficiary of IUC as every call that terminated on the Bharti network resulted in IUC revenues for Bharti. That has been reduced by TRAI and is likely to be further phased down over the next couple of years. It is hard to fathom how Bharti Airtel will sustain margins and remain profitable under these circumstances. Currently, the stock is riding on hype and you may sound pessimistic. But when you are skeptical, it is best to think with your feet! ©

Downstream Oil

Could the risk of oil subsidies come back all over again?

When the oil subsidies were gradually phased out over the last 3 years,there was a massive re-rating of downstream oil stocks like IOC, HPCL and BPCL. The results are there in the price and we have seen there turns over the last few years. The question is whether that story is likely to end now with oil prices crossing the psychological$60/bbl mark during the last few days.

Why oil prices will stay high…

When asked why oil prices will remain high in the next few months, the answer from an oil industry analyst was that “because the oil producers want it”. This is a slightly more nuanced argument. Take the 3 largest producers of oil in the world! Saudi Arabia is keen to keep prices buoyant as it will help the Saudi Aramco IPO to sail through. After all, they are looking at valuations closer to $2 trillion. Secondly, Russia has seen its macro situation worsen due to the negative impact of oil prices. That is one of the reasons why Russia has also enthusiastically participated with the OPEC in the supply cuts. Thirdly the US also wants to ensure that the debt taken on by Shale companies does not become an albatross around its neck.The best way is to keep them viable through higher oil prices. Above all, the demand supply gap is reducing as inventories are dwindling.Demand is rising and a spurt in oil consumption looks likely once the US embarks on its $1 trillion infra spending and tax cuts.

What does it mean for Oil cos?

The memories of the last 10 years are still vivid in the minds of people.With crude oil at above $100 per barrel, the Indian government had no choice but to force the downstream oil companies to subsidize some of the oil burden. When oil prices move up sharply, it is hard to keep passing on all the price hikes to the consumers. With elections coming up in key states and the general elections coming up in 18 months from now, that would be too politically sensitive. The government will not be comfortable with that. With most of the dividends of cheap oil creamed by the government in the form of higher excise duties on petrol and diesel, the government will be left with few options. The logical next step will have to be to ask Oil cos to take some of the burden. While it may not happen immediately, it would be inevitable if oil crosses $65/bbl.

What to do with downstream?

Frankly,it is time to be cautious on downstream oil. The price of oil may not really spurt to $100/bbl but the Indian government is already cutting its oil economics quite tight. A sharp rise in price of crude will mean greater burden on downstream oil companies and also reduced revenues for the government. That is not a happy scenario for downstream oil. There is a lull but there could be a storm coming! ©

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