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BIG NEWS – Sep 15th 2017

Posted on 15-Sep-2017 Comments  0

Reliance New High

Stock touches a life-time high after nearly 10 years…

Nearly 10 years after the stock of RIL touched an all-time high in January 2008, the stock once again reclaimed a life-time high during the week. The last rally in RIL had happened between 2005 and 2008 when the stock had actually been a multi-bagger. Interestingly, in the last one year the stock is up by over 80% and its market cap has touched Rs.5.30 trillion and it is the most valuable company in India today. Both TCS and HDFC Bank have some major catching up to do. In fact, RIL looks poised to be the first Indian company to scale $100 billion market valuation. But, what exactly were the triggers?

Healthy GRMs…

This is the bread and butter of RIL. The last few years has seen a massive surge in value of Reliance Industries. This has been largely led by the gross refining margins (GRM) of RIL consistently quoting at a premium of $4-5 over the Singapore benchmark. RIL GRMs at nearly$11-12/bbl are literally unmatched in the entire refining business.It is this healthy GRM that has enabled RIL to sustain its profit seven at a time when oil prices were weak. This out performance by there fining division has been one of the key factors that have helped RIL create a cash stash to fund its subsequent business investments.In addition, pet chem margins at RIL are also among the best in the industry. This has resulted in a long term re-rating of RIL.

Integration pays off…

The superior GRM and pet chem margins that RIL is enjoying today are largely an outcome of the big integration bet that the company has taken over the last 2 decades. It has built properties across oil extraction, natural gas, oil refining, marketing as well as downstream products like petrochemicals. This control over the entire hydrocarbon value chain helps RIL to earn superior margins compared to competition. Above all, in uncertain market conditions, the company is able to de-risk its overall business portfolio by shifting focus on the more lucrative ones. That is exactly what RIL has been doing in the light of weak oil prices!

Finally,it is all about Jio!

To be fair, the biggest chunk of the RIL out performance has coincided with the launch of Jio in September 2016. With a data-only focus and superior ARPUs compared to industry, RIL has had the luxury of falling back on its massive war-chest of oil profits to fund the telecom venture. The company has apparently sunk nearly Rs.250,000 crore into the telecom business but has gained approximately that much in terms of market cap in the last 1 year. Obviously, the shareholders are not complaining. Jio probably explains this new high for RIL and also underscores why this story may be much bigger that what is visible today! ©

The Bullet Train

The Japanese funding model is not all that simple!

It was, in many ways, called the deal of the century. The Japanese prime minister traveled down to India to lay the foundation stone for the project. Of course, the tougher job of acquiring the land, getting the clearances and actually executing the job is still pending. But that should happen, sooner rather than later. Also there are add-on benefits in the form of billions of dollars that has come in from companies like Suzuki, Denso and Toshiba. But the big question is on the funding part. Japan has to fund a large chunk of the $17 billion project with a 0.1% loan. Here are 3 key points we need to be aware of…

Not an economical solution…

The first question is whether India really requires a bullet train a tall. High speed trains make a lot of sense in smaller nations like Germany, Japan, France, Italy and Spain. In a country like India, it is not too clear whether it will add value. But the bigger concern is over the cost of the project. The Japanese costing is at least 60-70%higher than the cost at which China has implemented similar projects in its country. On a mega project of this size and magnitude, it does not really make sense to overpay to this extent. India, most likely,did not use Chinese technology due to the security issues involved,but that could have been handled and could have saved billions of dollars. It will be interesting to see the payback period for the bullet train!

But,it is a cheap loan…

That is a very easy and seductive argument to offer. Japan is funding a chunk of the project in the form of a 50-year lone repayable with an annual interest rate of 0.1%. This will be a yen-denominated loan,but that is not the point. The 0.1% loan is actually coming at a healthy spread for Japan. Remember, Japan is currently suffering from negative interest rates. While the BOJ has maintained the benchmark 10-year yields in positive territory, the effective rate of interest in Japan is negative. So Japan is going to earn a positive spread on the loan for the next 50 years. The cost becomes larger when consider that it has been over priced compared to similar Chinese projects.

Currency is the joker in the pack…

But the real joker in the pack could be the currency risk. Since it is a yen-denominated loan, all interest and principal repayments will be in yen. If the Yen appreciates by 5% in a year, then that 5% loss has to be borne by India! Remember, Japan with a current account surplus,is always looked at as a safe haven. The yen has appreciated sharply in the last one year and any future weakness in the Yen could be counter productive to India’s repayment capacity. Remember, we are risking currency movements over the next 50 years. That could be a much bigger risk than India bargained for! ©

GDP Worries

A host of downgrades are raising hackles over the GDP number…

From the time the MOSPI announced the first quarter GDP on August 31st,there have been consistent worries about the level of GDP for the full year. While the RBI continues to maintain the full year GDP at around the 7% mark, analysts and rating agencies are getting jittery.Firstly, UNCTAD downgraded India’s full year GDP for 2017-18 to 6.7% at an optimistic level. Then other banks like Nomura and DBS have also expressed concerns over whether GDP can be sustained at 7%.Here are 3 key parameters to watch out for…

Note ban and GST…

Try as we may, the ghosts of GST and the demonetization cannot be wished away. The pressure on manufacturing is still visible in the aftermath of the note ban. The cash crunch had forced most corporates to go slow on inventory purchase and investments. That is showing up in the form of lower growth. The worst hit has been the SME segment which forms the bulk of the contribution to the manufacturing sector. This segment has been squeezed by a cash crunch on the one hand and weaker payment cycles from their clients. GST is another challenge where the lag effect is being felt. Firstly, the companies focused on inventory depletion at the cost of production. Then the confusion over GST is adding up and there is still a lot of work to be done on the technology front. GST will continue to be an overhang.

Exports are hardly flattering…

To be fair, exports are growing on a YOY basis, but India does not seem to be really benefiting from a pick-up in global trade. That is largely due to a strong INR. A strong rupee is turning out to be advantageous for importers and negative for exporters. India, which imports nearly 80% of its oil requirements, is benefiting from the dividends of cheap oil, but that is coming at the cost of exports.Most of these exports are fed by SMEs and they are feeling the additional pressure of a strong rupee. Till the time exports get a boost, GDP is likely to remain strained.

Where are the investments?

That is the million dollar question. GDP gets a leg-up when there is capital spending and a revival in the capital cycle. Normally, the capital cycle has strong externalizes as its positive impact rubs off on many downstream sectors. In the absence of any revival in the capital cycle, the downstream sectors are largely constrained. The latest data coming from the IIP front indicates that while the capital sector de-growth is getting better, it is nowhere close to bottoming out. With most sectors operating at around 70% capacity,nobody really has an incentive to invest. More so, when demand is solute warm in the economy! Till that is sorted out, GDP growth may struggle to break above the 7% mark! ©

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