Tag Archives: government

India- An Attractive Destination For Long-Term Growth

Summary India is poised for a robust economic recovery on the backdrop of strong fundamentals. Slowdown in China created ripple effects across emerging markets, but India looks like an attractive alternative. Narendra Modi government’s efforts on making India a manufacturing hub to catalyze economic recovery. For those who have been tracking the equity markets, last month has been quite a rollercoaster ride. The global sentiments remained weak with negative news flowing from China with respect to their economy. The Chinese economy grew by 7.4% in 2014, which is the slowest in 24 years. In an attempt to boost its exports and revive the economy, China announced a devaluation of its currency. This triggered panic selloff across markets. Emerging markets got the maximum impact. In an attempt to prevent the falling stock prices, the People’s Bank of China reduced its interest rates twice during the last couple of months. But, this failed to entice global investors and panic prevailed. The story in India looks quite different from its peers. The country is in a much stronger wicket compared to its peers. While the US Fed is mulling over increasing its interest rates, the Reserve Bank Of India (RBI) surprised the markets on 29th September with a 50 basis points (bps) cut in the repo rate. The rationale for the same is as follows. ( RBI’s Policy Statement ) Retail inflation has eased significantly to 3.66% in August 2015 as against 7.73% in the same month previous year. ( India’s Inflation ) The monsoon deficit in India has been around 14% this year. However, the central government has taken resolute steps towards managing food supply. Economic recovery has been slower than expected. This rate cut, combined with the 75 bps rate cut done during this year by the central bank is expected to bring down the cost of borrowing. This can encourage fresh borrowing and can propel capital expansion. For companies that already have significant debt on their books, their interest cost is expected to come down, thereby increasing profit margins. On the backdrop of a slowing Chinese economy, global commodity prices have been low. While this may be a negative for countries exporting commodities, it is a huge positive for India as it is an importer and consumer of commodities. India imports close to 80% of its oil requirements. Crude oil prices have fallen sharply over the last one year, and this will have a huge positive impact on the current account of India. It is evident that an economic recovery is underway. The RBI has also stated this clearly in its monetary policy review on 29th September 2015. It has been 15 months since the Narendra Modi government has taken charge and the fundamentals look robust. The Make in India Campaign – With the government encouraging foreign companies to set up their factories in India, this campaign will definitely boost manufacturing, construction, power, infrastructure, technology and logistics sectors. The government is striving hard to make it easier to do business in India. This can definitely attract more foreign funds to the country. While earnings growth was subdued in the previous quarter, it is expected to be robust. With the domestic demand picking up and global economy recovering (healthier data from US and Europe), earnings are expected to improve over the next 3 to 5 years. Softer commodity prices is a huge positive as it will result in improving margins and increased profitability. China has been witnessing increase in the cost of labour and real estate. In comparison, India looks like an attractive alternative for companies to move into. Considering these factors, Indian equities definitely look attractive as an investment destination. In this light, an evaluation of The India Fund, Inc (NYSE: IFN ) is given below. Fund Investment Objective: The fund’s investment objective is long-term capital appreciation, which it seeks to achieve by investing primarily in the equity securities of Indian companies. Investment Philosophy: Bottom-up stock selection Proprietary research driven Based on fundamental analysis Factsheet Download Performance: As on 31st August 2015 The fund has a well-established track record of over 20 years. As it is evident from the past performance, the NAV has beaten the MSCI India Index over the short-term and the long-term. This superior performance can be attributed to a) Superior stock selection of the fund; and b) Fund manager’s ability to manage sector-wise weightings effectively. Top 10 Holdings: As on 31st August 2015 Sector Allocation: As on 31st August 2015 The portfolio consists of fundamentally strong companies that would be benefited as the economic recovery happens in India. The top 10 holdings constitute 58% of the portfolio. The portfolio is diversified across 9 sectors and has a balance between both cyclical and defensive companies. The fund has highest weighting to financial services. With the central bank cutting the repo rate by 50 bps and the outlook for interest rates moving southwards in the next 12 to 18 months, financial services are expected to play a key role in economic recovery of the country. Information Technology and Consumer Staples have a weighting of around 17.5% each to the portfolio. Information Technology plays an important role in the exports of the country. With the US Dollar strengthening against the INR, these companies can be benefited due to increased US Dollar revenues. The Consumer Staples companies in the portfolio, especially ITC, Hindustan Unilever and Godrej Consumer Products have very low debt, well-established brands and a strong hold in the Indian consumer market. The other key sectors that are expected to contribute to the fund’s performance are Healthcare and Industrials. Healthcare has a weighting of 10.1%. Growth is expected to come from both the domestic markets and exports. Industrials have a weighting of 5.3%. This sector will be benefited significantly as the Make in India campaign becomes a reality and as manufacturing activity improves. The cash level in the portfolio is just 1%. As it is a closed-ended fund, it need not maintain high cash levels to fund redemption requests as they are not allowed. As on 1st October 2015, the closing price of the fund was $24.27 while the NAV of the fund was $27.54. It is currently trading at a discount of 11.87%. IFN data by YCharts Forward Looking Estimates The RBI, in its latest monetary policy review has projected a GDP growth of 7.4% for the year 2015-16. The International Monetary Fund (NYSE: IMF ) too has projected a GDP growth of 7.5% for the same period. This is higher than its estimate of China’s GDP growth which is 6.8%. With an inflation projection of around 5%, the portfolio companies are expected to deliver a robust 13-15% growth in earnings over the next 3 to 5 years. The fund also has a healthy track record of generating superior returns than the benchmark. Considering the robust macro-economic factors in India and with limited number of India-dedicated funds listed in the US, The India Fund, Inc fund looks attractive for long-term wealth creation. Fund Management Team: Asian Equity Team based in Singapore Net Assets: $824.1 million Expense Ratio: 1.47% Shares Outstanding: 29,541,212

COPEL Is Much More Stable Than CEMIG, But The Potential Upside Is Also Lower

Summary COPEL’s business is sound, with slow growth, low debt, a good dividend, good fundamentals and a good, stable historical performance. Due to the situation in Brazil, there is still more downside potential for the stock. CEMIG is a much more risky play, but the upside is also much higher. Introduction I recently wrote an article where I analyzed investment opportunities in Brazil that are listed on the NYSE and gave an overview of the economic situation. I found four interesting companies, of which BrasilAgro (NYSE: LND ) and Brasil Foods S.A. (NYSE: BRFS ) are good, but their P/E ratio is too high. This leaves us with two electrical companies, CEMIG (NYSE: CIG ) and Companhia Paranaense de Energia – COPEL (NYSE: ELP ). I have already written about CEMIG here and here , so in this article, I will analyze COPEL. About ELP ELP is the largest company of the State of Paraná (South Brazil), and serves electricity to 4,370,200 units. The company uses 18 hydroelectric plants that give 99.5% of its own electrical production, 1 thermal plant and 1 wind plant, with total installed capacity of 4,754 MW, a transmission system with 2,302 km of lines and 33 substations, a distribution system which consists of 192,116 km of lines and network of up to 230KV, and an optical telecommunication system. The company was founded in 1954, and has been listed on the NYSE since 1997. The State of Paraná is the major shareholder, with 58% of voting shares. There has been a lot of regulatory turbulence in the energy sector lately, especially with CIG losing 45% of its electricity generation capacity due to lost concessions. Energy prices increased and are currently under the red flag 3 regime, meaning that the electrical utilities sector is under pressure. The result of this is that ELP’s revenues increased 32% in Q2 2015, mostly due to price increases. Operating expenses increased even more, around 38% in the same period. The Business One of the main issues in the sector is that all the assets are mostly under concession from the government, but with the latest news on concessions, where the Federal Audit Court authorized the government to renew for another 30 years the concessions for electricity distributors whose contracts expire between 2015 and 2017, the situation is more stable now as compared to that a month ago. This is good news for ELP, as in the Q2 earnings conference call, the company did not know if its distribution concessions would be prolonged. As for electricity production, the situation with ELP is much more stable than it is with CIG, because ELP has only 5% of electricity production in doubt for 2015, whereas CIG had 45% of production in doubt, and eventually lost it. According to ELP’s CEO , the company will bid to renew the concessions and are pretty sure it will happen. The two plants in question are the Parigot de Souza and Mourão plants. ELP is also developing new projects, building 2,000 km of new distribution lines and developing new wind farms, with three new farms expected to start up in upcoming weeks. Fundamental Analysis The current P/E ratio is 7.91, and the price-to-book value is 0.6. In Table 1, you can see the main fundamental indicators for ELP and their stability in the Brazilian currency. Table 1: ELP Fundamentals 2010-2015 (Source: Morningstar ) In the Brazilian currency, ELP is able to transfer the increase in prices to its customers, which shows it to be a great hedge against inflation. The net income is pretty stable for a regulated electrical company, and it can be assumed with a high degree of certainty that ELP will continue to operate less or more positively in the future. The dividend is also stable, and the company has a policy of paying at least 25% of its net profits in dividends. This means that with the trailing earnings, an investor can expect minimally US$0.25 per share at the current exchange rate. This would give a 3% dividend yield at current prices and exchange rates. The gross margin is slowly deteriorating, but we can expect it to improve as soon as the extraordinary circumstances in the Brazilian energy market pass. Technical Analysis The main issue here is not ELP’s business or its fundamentals, but the volatility of the exchange rate between the US dollar and the Brazilian real. In Figure 1, you can see that an end to the depreciation of the real is nowhere to be seen. Figure 1: Brazilian real per US$1 from 2005 to 2015 (Source: XE.com ) I cannot predict what will happen here in the next few years. Currently, the situation in Brazil is far from stable, but in the period from 2009 to 2011, the real appreciated against the US dollar by 60%. We could say that there is blood on the Brazilian financial markets now, and usually, these are the best times to buy. But the main question is: How low can the real go? On the other hand, if we see an improvement in the political and economic situation in Brazil, the exchange rate trend would quickly switch and create a point of stability at a certain level. This trend reversal could give a 25% currency gain and add an extra 25% to the dollar EPS of ELP. This is a scenario that would easily create a 50% return for international investors. But we would need a crystal ball to know when the bottom will be reached in Brazil. Conclusion If ELP were a European or US company, I would probably buy it at these ratios, expecting a healthy 13% yearly return and a 3-4% dividend that would allow me to repurchase shares. With the uncertain situation in Brazil and the real depreciating at a 10% monthly rate (August and September 2015), I want a much wider margin of safety. The margin of safety that I would look for to feel comfortable investing in ELP would be one that gives me a 15% return even if the real depreciates by another 50%. This means that for US$1, we would get R$6. In such a scenario, ELP’s EPS would be US$0.66, and to get a 15% return, the P/E ratio should be 6.66 – meaning that a safe entry-level stock price for ELP is US$4.4. We are still far from that, but everything is possible considering the current situation. ELP is very stable, and Brazil is very unstable for sure in the short term, but potentially stable in the long term. Such a situation makes me believe that there might be a chance of the stock falling a little bit more, and thus, increasing the safety margin for investors. My advice would be put this company on a watch list, estimate your required rate of return for such an investment, adding to that the potential further depreciation of the real, and thus get to a safe entry price for yourself. Comparison with CIG ELP’s price-to-book ratio is 0.6, and CIG’s is currently at the same level. The P/E ratio is 8 with ELP and 3 for CIG, but with the unclear future earnings stream for CIG due to the loss of the concessions on 40% of its energy production, the difference is justified. I do not see potential spectacular earnings growth with ELP, because it is a stable company that aims for sustainable growth, whereas with CIG, everything is possible due to the management’s more risky approach to business. CIG has the potential to bring EPS to $US1.5 per share that would give a P/E ratio of 1.13 at current prices and a dividend yield of around 40%. The risk-reward ratio is 50% downside and 50% upside with ELP, while with CIG, it is 50-100% downside and 600% upside. I will continue to follow the two companies, and if the divergence between the perception the investor community has about Brazil and the businesses’ results continues to grow, thus lowering the potential downside, I will start buying. So, for now, I will put both companies on a watch list and let you know more in the future.

VWO: A Very Solid Emerging Market ETF, If You Don’t Mind China

Summary VWO offers some solid diversification among the companies and a low expense ratio. When investors look at diversification based on geography, the diversification is not as favorable. I’d like to see a lower allocation to China and stronger allocations to smaller emerging markets. When investors look at the correlation between VWO and major domestic indexes on a daily basis, the correlation looks very high. Over the long term, the high correlation breaks and there is a dramatic difference in returns even over periods of a few years. Investors should be seeking to improve their risk adjusted returns. I’m a big fan of using ETFs to achieve the risk adjusted returns relative to the portfolios that a normal investor can generate for themselves after trading costs. One of the funds that I’m considering is the Vanguard FTSE Emerging Markets ETF (NYSEARCA: VWO ). I’ll be performing a substantial portion of my analysis along the lines of modern portfolio theory, so my goal is to find ways to minimize costs while achieving diversification to reduce my risk level. Expense Ratio The expense ratio on VWO is only .15%. Nice work Vanguard, this is another low cost index fund for effective diversification. Largest Holdings (click to enlarge) The holdings for VWO are fairly diversified with only 2 companies receiving an allocation higher than 2.1%. The one concern I have is that it seems like “China” keeps coming up in the top holdings. I checked the allocation by country to determine how large that exposure would be. Allocation by Country The allocation to China was 27.1% of the market. Since I’ve been a bear on China, I’m not really big on this allocation. I wasn’t bearish on China until their domestic equity market doubled. While the government in China is working hard to protect their equity valuations, I’d rather see the economy growing rapidly from people working and building both infrastructure and exports. I would prefer an emerging market portfolio with an international diversification that was closer to equal weights. It wouldn’t need to actually be equal weight, but less skewed than the current portfolio. Building the Portfolio This hypothetical portfolio has a moderately aggressive allocation for the middle aged investor. Only 25% of the total portfolio value is placed in bonds and a fifth of that bond allocation is given to high yield bonds. If the investor wants to treat an investment in an mREIT index as an investment in the underlying bonds that the individual mREITs hold, then the total bond allocation would be 35%. Given how substantially mREITs can deviate from book value, I’d rather consider the allocation as an equity position designed to create a very high yield. This portfolio is probably taking on more risk than would be appropriate for many retiring investors since a major recession could still hit this pretty hard. If the investor wanted to modify the portfolio to be more appropriate for retirement, the first place to start would be increasing the bond exposure at the cost of equity. However, the diversification within the portfolio is fairly solid. Long term treasuries work nicely with major market indexes and I’ve designed this hypothetical portfolio without putting in the allocation I normally would for equity REITs. An allocation is created for the mortgage REITs, which can offer some fairly nice diversification relative to the rest of the portfolio and they are a major source of yield in this hypothetical portfolio. The portfolio assumes frequent rebalancing which would be a problem for short term trading outside of tax advantaged accounts unless the investor was going to rebalance by adding to their positions on a regular basis and allocating the majority of the capital towards whichever portions of the portfolio had been underperforming recently. Because a substantial portion of the yield from this portfolio comes from REITs and interest, I would favor this portfolio as a tax exempt strategy even if the investor was frequently rebalancing by adding new capital. The portfolio allocations can be seen below along with the dividend yields from each investment. Name Ticker Portfolio Weight Yield SPDR S&P 500 Trust ETF SPY 35.00% 2.06% Consumer Discretionary Select Sector SPDR ETF XLY 10.00% 1.36% First Trust Consumer Staples AlphaDEX ETF FXG 10.00% 1.60% Vanguard FTSE Emerging Markets ETF VWO 5.00% 3.17% First Trust Utilities AlphaDEX ETF FXU 5.00% 3.77% SPDR Barclays Capital Short Term High Yield Bond ETF SJNK 5.00% 5.45% PowerShares 1-30 Laddered Treasury Portfolio ETF PLW 20.00% 2.22% iShares Mortgage Real Estate Capped ETF REM 10.00% 14.45%   Portfolio 100.00% 3.53% The next chart shows the annualized volatility and beta of the portfolio since April of 2012. (click to enlarge) A quick rundown of the portfolio Using SJNK offers investors better yields from using short term exposure to credit sensitive debt. The yield on this is fairly nice and due to the short duration of the securities the volatility isn’t too bad. PLW on the other hand does have some material volatility, but a negative correlation to other investments allows it to reduce the total risk of the portfolio. FXG is used to make the portfolio overweight on consumer staples with a goal of providing more stability to the equity portion of the portfolio. FXU is used to create a small utility allocation for the portfolio to give it a higher dividend yield and help it produce more income. I find the utility sector often has some desirable risk characteristics that make it worth at least considering for an overweight representation in a portfolio. VWO is simply there to provide more diversification from being an international equity portfolio. While giving investors exposure to emerging markets, it is also offering a very solid dividend yield that enhances the overall income level from the portfolio. XLY offers investors higher expected returns in a solid economy at the cost of higher risk. Using it as more than a small weighting would result in too much risk for the portfolio, but as a small weighting the diversification it offers relative to the core holding of SPY is eliminating most of the additional risk. REM is primarily there to offer a substantial increase in the dividend yield which is otherwise not very strong. The mREIT sector can be subject to some pretty harsh movements and dividends from mREITs should not be the core source of income for an investor. However, they can be used to enhance the level of dividend income while investors wait for their other equity investments to increase dividends over the coming decades. If you want a really quick version to refer back to, I put together the following chart that really simplifies the role of each investment: Name Ticker Role in Portfolio SPDR S&P 500 Trust ETF SPY Core of Portfolio Consumer Discretionary Select Sector SPDR ETF XLY Enhance Expected Returned First Trust Consumer Staples AlphaDEX ETF FXG Reduce Beta of Portfolio Vanguard FTSE Emerging Markets ETF VWO Exposure to Foreign Markets First Trust Utilities AlphaDEX ETF FXU Enhance Dividends, Lower Portfolio Risk SPDR Barclays Capital Short Term High Yield Bond ETF SJNK Low Volatility with over 5% Yield PowerShares 1-30 Laddered Treasury Portfolio ETF PLW Negative Beta Reduces Portfolio Risk iShares Mortgage Real Estate Capped ETF REM Enhance Current Income Risk Contribution The risk contribution category demonstrates the amount of the portfolio’s volatility that can be attributed to that position. Despite TLT being fairly volatile and tying SPY for the second highest volatility in the portfolio, it actually produces a negative risk contribution because it has a negative correlation with most of the portfolio. It is important to recognize that the “risk” on an investment needs to be considered in the context of the entire portfolio. To make it easier to analyze how risky each holding would be in the context of the portfolio, I have most of these holdings weighted at a simple 10%. Because of TLT’s heavy negative correlation, it receives a weighting of 20% and as the core of the portfolio SPY was weighted as 50%. Correlation The chart below shows the correlation of each ETF with each other ETF in the portfolio. Blue boxes indicate positive correlations and tan box indicate negative correlations. Generally speaking lower levels of correlation are highly desirable and high levels of correlation substantially reduce the benefits from diversification. (click to enlarge) Conclusion VWO is benefiting a great deal from having a fairly low correlation with several of the other assets in the portfolio. The highest correlation is with the S&P 500, but even the high level of correlation established here is a function of the very short term measurements being used to measure the correlation. When returns are measured over a longer time period the correlation decreases significantly. Over the sample period the S&P 500 is up by 52% and VWO is down by 12%. Simply put, short term correlations are resulting in significantly overstated correlations for VWO. In the same manner, I think the benefits of diversifying VWO with a long term treasury ETF are understated. When investors are in a period of panic, emerging markets will tend to go down while the risk free securities will be bid higher. If investors want to use a fund like VWO to grab some international diversification (with some heavy exposure to China), I would really for treasuries to be over-weight in the portfolio. The difficulty here is that long term rates are already fairly low so the maximum level of gains on a treasury allocation is limited. All around this is a good ETF, but I would prefer international options with less exposure to China. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Additional disclosure: Information in this article represents the opinion of the analyst. All statements are represented as opinions, rather than facts, and should not be construed as advice to buy or sell a security. Ratings of “outperform” and “underperform” reflect the analyst’s estimation of a divergence between the market value for a security and the price that would be appropriate given the potential for risks and returns relative to other securities. The analyst does not know your particular objectives for returns or constraints upon investing. All investors are encouraged to do their own research before making any investment decision. Information is regularly obtained from Yahoo Finance, Google Finance, and SEC Database. If Yahoo, Google, or the SEC database contained faulty or old information it could be incorporated into my analysis.