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Section D : Case Study (50 Marks) · This section consists of questions with serial number 1 - 5. · Answer all questions. · Marks are indicated against each question. · Do not spend more than 80 - 90 minutes on Section D. Case Study Read the case carefully and
answer the following questions: 1. Perform Michael Porter’s Analysis of the Indian Fertilizer Industry. (10 marks) < Answer > 2. a. Perform ROE analysis of Gujarat Narmada Valley Fertilizers Company Ltd.(GNFC) for last four years based on the Financial Statements given in Annexure I. b. Calculate Cash Earning Per Share (CEPS) of the Gujarat Narmada Valley Fertilizers Company Ltd. (GNFC) during the last four years. Make comparative analysis of CEPS with EPS. (8 + 5 = 13 marks) < Answer > 3. Calculate the intrinsic value of the equity of Gujarat Narmada Valley Fertilizers Company Ltd. (GNFC) as on 1.04.2004 as per the formula given below: P0 = 0.35 ´ PDDM + 0.65 ´ PRegression PRegression = 47.25 + 10.25 ´ DP + 25.45 ´ GR – 0.89 beta + 45.8 ROE Where, DP = Average dividend Payout Ratio, (%) GR = Average growth rate in earnings, (%) ROE = Average Return on Equity, (%) b = Beta of GNFC stock (relevant data appears in Annexure I to the case.) PDDM = Price as per the DDM. GNFC will continue to maintain a dividend rate of 25%. The growth rate in the earnings will be 20% for the next 5 years and 10% thereafter. The face value of GNFC share is Rs 10 and risk free rate is 5.5%. (12 marks) < Answer > 4. Comment on whether stock should be bought or sold at points A, B, C, D and E based on the chart given in Annexure I. (10 marks) < Answer > 5. Discuss the leading economic indicators that are significant to Fertilizer Industry. (5 marks) < Answer > Fertilizer Industry Fertilizers play a vital role in
the Indian economy, which still is largely dependent on agriculture, helping
to produce sufficient foodgrains for the Indian population of over 1 billion.
Agriculture accounts for 25% of GDP and the contribution of fertilizer
industry to GDP is significant. The
vibrant Indian fertilizer industry, with huge capital investments is the
third largest producer and consumer of Fertilizers, next only to China and
United States. It also generates substantial employment. The fertilizer
industry facilitates the country in its quest for self-sufficiency in
agricultural production. Towards this end, it aims at appropriate utilization
of Fertilizers for optimum yield of crops. The
industry as such is undergoing a painful transition from the subsidized
environment of earlier times towards a de-controlled market of the post-liberalization.
The industry also faces threat from the global environment on account of
removal of Qualitative Restrictions (QRs) and WTO bound rates in respect of a
few Fertilizers. Industry Structure Fertilizers basically provide primary, secondary and
micronutrients that are essential for the normal growth of plants. Primary
nutrients are Nitrogen (N), Phosphorous (P) and Potassium (K). Secondary
nutrients are calcium, magnesium, and sulfur while micronutrients are boron,
chlorine, cobalt, copper, iron, manganese, molybdenum, sodium, and zinc. The
most widely used Fertilizers include nitrogenous (N) - 70% of consumption,
Phosphorous (P) - 22% and potassic (K) - 7%. Potassic fertilizer is not
manufactured in India and imports accounts for total consumption. Urea
accounts for 85% of the nitrogen consumption, followed by Di-Ammonium
phosphate (DAP) and others accounting for 15%. Likewise, over 66% of the
phosphate consumption are by DAP, followed by Single Super Phosphate (SSP) at
14%. The
production of nitrogenous Fertilizers in the country is based on various feed
stocks. Of the total production capacity nearly 20 million MT of urea, 58%
comes from gas based plants, 30% from naphtha and 12% from fuel oil / Low
Sulphar Heavy Stock (LSHS) / mixed feed stocks. India is largely
self-sufficient in these feed stocks although India is a net importer of
crude oil. Inadequate availability of natural gas supply is a growing cause
for concern and alternatives like import of LNG are under active
consideration. Of the two other major nutrients, phosphorus is mostly
manufactured from imported rock phosphates or from phosphoric acid while all
potash is imported. The
first fertilizer manufacturing unit was set up in 1906 at Ranipet near
Chennai with a production capacity of 6000 mt of Single Super Phosphate per
annum. With this humble beginning the Indian fertilizer sector over the years
took a quantum leap. There are 64 large size fertilizer units in the country,
manufacturing a wide range of nitrogenous and phosphatic/complex fertilizers.
Of these, 39 units produce urea, 18 units produce DAP and complex
fertilizers, 7 units produce low analysis straight nitrogenous fertilizers
and 9 of the above units produce ammonium sulphate as a by-product. Besides,
there are about 79 small and medium scale units producing single
superphosphate. The total installed capacity of fertilizer production in the
country is 110.71 lakh tonnes of nitrogen and 36.48 lakh tonnes of phosphate
as on 29 February 2000. The
domestic fertilizer demand was met largely by imports till mid-1970s. To
reduce import dependence, the government implemented a Retention Pricing
Scheme (RPS) in 1977. The objectives of the scheme were to increase
consumption and production of fertilizers, ensure availability at an
affordable price and give a reasonable return to the producers. Till
August 1992, the fertilizer industry was fully regulated by the Government
under the protective umbrella of the RPS, a unit-wise cost-plus scheme that
assured a fixed rate of return on the net worth for each unit. However, in
1992, the Government, faced problem of mounting fertilizer subsidy bill,
lifted the pricing and distribution controls on P and K Fertilizers while
retaining N Fertilizers under the regulatory regime. As of now, urea is the
only fertilizer still regulated by pricing and distribution controls. The leading listed companies in the industry are
Southern Petrochemical Industries (Spic), National Fertilizers (NFL),
Rashtriya Chemicals & Fertilizers (RCF), Gujarat Narmada Valley
Fertilizers Company Ltd. (GNFC), Nagarjuna Fertilizers & Chemicals (NFCL)
Fertilizers & Chemicals Travancore (Fact), Zuari Industries, Chambal
Fertilizers & Chemicals, etc. The leading unlisted companies are Indian
Farmers Fertilizer Co-operative (Iffco), Krishak Bharati Co-operative
(Kribhco). Cost Structure Raw
materials constitute about 54% of sales, followed by power and fuel cost at
16% and other manufacturing costs at 10%. The key raw materials used in
production of Fertilizers are ammonia, phosphoric acid and sulphur. Ammonia
is the major raw material used to produce nitrogenous and complex
Fertilizers. Similarly, rock phosphate, sulphur, phosphoric and sulphuric
acid are vital intermediaries for production of complex and phosphatic Fertilizers.
Ammonia
can be produced from feedstocks like natural gas, naphtha or fuel oil.
However, the country is constrained by the non-availability of the above
feedstock of good quality in sufficient quantities. Though natural gas is the
cheapest raw material, currently all the above feedstock, apart from coal, is
used to produce ammonia, despite huge cost variations. About 8% of the country's ammonia
requirement are being imported, mainly from Middle East, Indonesia and Former
Russian States (FRS). Similarly, while the entire potassic Fertilizers are
imported, about 68% rock phosphate and about 79% of phosphoric acid are
imported, due to non/poor availability of these chemicals/Fertilizers in
India. Hence, the cost of production in India is grossly on a higher side,
and sometimes, it is even higher than the international prices of finished
product. The
industry is highly capital intensive and therefore, over 12% of sales are
incurred as interest cost. Depreciating rupee also adds to the cost, as most
of the raw materials are imported. Policy Impact In Oct.
2002, the group of ministers, finalized a draft fertilizer policy, laying
emphasis on efficiency in operations of urea manufacturing units and
envisaging switch over from the existing unit-wise retention
price-cum-subsidy (RPS) scheme to Group Concession Scheme (GCS) for
indigenous urea plants in a phased manner. The group's recommendations were
broadly in line with the report of the Expenditure Reforms Commission and is
expected to substantially reduce the subsidy burden. As per
the recommendations, fertilizer units will be will be divided into six groups
based on their technological vintage and feedstock. The units in each group
would be allowed concessions based upon the weighted average retention prices.
Effective
from June 2002, the pricing policy for the Seventh and Eighth pricing periods
under the existing RPS was notified. In
India, the Fertilizers providing primary nutrients nitrogen (N), phosphate
(P) and potassium (K) are subsidized by the government. Further, the
fertilizer price, distribution and movement were controlled through
Fertilizer Control Order (FCO) and Fertilizer Movement Control Order (FMCO)
under the Essential Commodities Act. Considering
the strategic importance of this core sector industry, the Union Government
has been addressing issues and concerns relative to the industry through its
policies. As a result of partial decontrol of the P&K Fertilizers in
August, 1992, the NPK usage in the country got adversely affected. The NPK
use ratio, which was at 5.9:2.4:1 during the pre-decontrol period
deteriorated to 9.7:2.9:1 after the decontrol in 1992. This adverse ratio was
due to spurt in prices of decontrolled Fertilizers. While the prices of urea
were heavily subsidized, post-decontrol, the phosphatic fertilizer prices
zoomed, thereby forcing the farmers to use more of urea than of other
Fertilizers. However, with the introduction of ad hoc concessions for P&K
Fertilizers, the ratio improved to 7:2.7:1 during the year 2000-01, against
the agronomically desirable ratio of 4:2:1. Realizing
the need for balanced application of Fertilizers for optimum yield of crops,
the government had introduced ad-hoc subsidies for decontrolled Fertilizers
and to set right the nutrient imbalance in the soil. Currently Urea is the
only fertilizer under the control of Retention Price System (RPS) and all
other Fertilizers are governed by ad-hoc concession scheme with the MRPs
fixed by the Union Government. In view
of the overriding need to rein in the fiscal deficit, fertilizer subsidy is a
major issue for the Government. The subsidy burden of the Central government
for Fertilizers went up sharply from The
uncertainty in the policy environment in fertilizer industry continued during
2001-02. The recommendations of the Expenditure Reforms Commission (ERC) for
the phased de-regulation of urea and increase in price of urea by 7% per
annum beginning 1st April, 2001 has not been implemented. However, retention
prices of 13 units including 6 based on naphtha, 5 on gas and 2 on fuel oil /
LSHS have been revised downward with retrospective effect from 1st April,
2000 on the basis of interim revision in consumption norms. The reduction in
retention price is steep, particularly for naphtha-based plants and ranges
from Rs.1000 to Rs.1900 per MT. In pursuit of its policy towards phased decontrol of
the fertilizer industry, the Government has increased the selling price of
all Fertilizers by about 5%-7% the year 2002-03. As regards Complex
Fertilizers, the Tariff Commission, which was entrusted with the study of the
cost of production/sale of Complex Fertilizers and suggest a formula for
future subsidy calculations, had proposed that the Complex Fertilizer
manufacturers be divided into two groups viz. Group I consisting of those
using imported ammonia or manufacturing ammonia from gas and Group II
comprising of those manufacturing Ammonia from Naphtha, Fuel Oil and Mixed
Feed. The 'P' manufacturers have represented to the Government the need to
have a uniform norm for calculating the concession and the need to avoid
splitting the industry into two. The Government's final decision on the
matter is awaited. The Commissions recommendations, if implemented, would put
efficient manufacturers at some disadvantage as compared to high cost
manufacturers of complex Fertilizers. Further, there was no incentive for the industry to
become cost effective, as subsidy was linked to the cost of each unit. Hence,
the government plans to phase out subsidies and progressively decontrol the
entire fertilizer industry, to make it globally competitive. The basis for
formulating seventh and eighth pricing periods and the formulation of a Long
Term Fertilizer Pricing Policy is under active consideration of the
Government. The Industry through Fertilizer Association of India has made
rigorous representations to the Government of India for a pragmatic policy
for this core sector industry. The Group of Ministers (GOM) has also proposed that the
normative capacity utilization for all gas based units be assessed at 95%
from 1.4.2002 while the same for naphtha/fuel oil based plants be fixed at
90%. Currently, these are assessed at 90% 1and 85% respectively. Current Industry Status The
reduced availability of gas as feedstock is the major constraint the industry
faces today. Though the recent gas finds by ONGC and Reliance are welcome,
they are still inadequate to cater to the growing need of the fertilizer,
power and other industries. Also as the fertilizer consumption is by the
farming community, demand depends on the quantum of rains in a particular
year. Further, the manufacturing capacity available in the country being
close to the level of overall demand, any glut due to adverse monsoon affects
the sale. The FY
2001-02 has been a challenging one for most of the economies globally. The
Indian economy was also affected, a major contributor to the slowdown was the
lower growth in the industrial sector which was partially offset by the
higher growth in the services sector and an improvement in the agricultural
sector on the back of a better than average monsoon. The
agriculture sector, after two years of stagnation has grown by 7% during FY
2001-02, thanks to the favourable monsoon well distributed across major parts
of the country. However due to downward revision in the energy consumptions
norms and upward reassessment of plant capacities and consequent reduction in
the Retention Price coupled with restrictions on production have affected the
profitability of the industry in the year 2001-02. The fertilizer production
in FY 2001-02 decreased 0.7% to 14566.40 thousand tonnes as against an
increase of 3% to 14667.70 thousand tonnes in FY 2000-01. However the import
of manufactured fertilizer increased by 3.6% in FY 2001-02 to 3223.51
thousand tonnes as against 54.1% fall to 3111 thousand tonnes in FY 2000-01. Weather
and government’s subsidy policy are the two most important determinants of
fertilizer use in India. The monsoon in the current year 2002-03 has been
scanty and the country had to contend with the worst drought in 13 years.
Weak rains in June and very scanty rains in July have caused extensive damage
to the 2002 kharif crops. However rains were normal during August. This has
improved the deficiency in the cumulative rainfall from 32% as of end July to
23% by end August. The first offical assessment of kharif crops during
2002-03 has placed production of all crops below the previous kharif seasons
level. However the cumulative fertilizer production during April - November
2002 was marginally higher by 2.8% to 9905.40 thousand tonnes as against fall
of 3.6% to 9636.50 thousand tonnes in the corresponding previous period. However
the country's dependence on fertilizer imports have decreased during the
above period, as imports of manufactured fertilizer dropped by 37.6% to
1402.39 thousand tonnes as against increase of 3.9% to 2246.27 thousand
tonnes in the corresponding previous period. Fertilizer
industry is passing through very difficult times due to change in policy
parameters, increasing cost of production and reducing margins. However,
long-term prospects remain encouraging as the increasing population of the
country necessarily requires more food production and in turn more
Fertilizers consumption. Moreover, politically and socially it will not be
feasible to give preference to imports over domestic fertilizer even if
economically preferable. Prevailing Tax Rates and Provisions While
urea is under statutory price, distribution and movement control of the
Government of India, Phosphatic and Potasic Fertilizers continue to be under
the indirect control of the Central and State Governments. The
system evolved in 1977 of a unit specific retention price was expected to be
replaced by the Government by a more uniform normative policy. Over the
years, the Government had appointed various committees, which had gone into
this aspect. The
Government had imposed a Special Additional Duty (SAD) of 4% on Imported Rock
Phosphate and Sulphur in addition to the basic duty of 5%. The
Finance Minister in his budget for the year 2001-02 had proposed to implement
the recommendations made by Expenditure Reform Commission (ERC). ERC had
recommended replacement of the current unit-wise retention price scheme by a
group-wise retention price scheme. However there was no final decision taken
on the same in the 2002-03 budget. Later the
Government of India proposed to implement VIIth and VIIIth pricing period
policy for urea subsidy prior to the implementation of ERC recommendation. Mounting pressure of subsidy on fiscal deficit of the
country has compelled Government of India to take a decision to gradually
withdraw the subsidy, heading towards total decontrol in a phased manner. A
long term policy for fertilizer sector has been thus recently considered by
the government, covering the problems of feedstock, fertilizer pricing, total
decontrol, WTO related issues, etc. The
government recently have approved a new pricing policy for urea units which
will replace the existing Retention Price Scheme and will come into effect
from 1.4.2003 based on the submissions of the Group of Ministers (GOM). The
main objective of the new pricing policy for urea manufacturing units, is to
bring in greater transparency, uniformity and efficiency in subsidy payments
to the fertilizer companies. Besides, it is also to encourage them to take
measures on their own to promote efficiency and bring down the cost of
production. This policy is likely to result not only in savings in subsidy
expenditure but also promote the efficient use of scarce energy resources. The new scheme, will be implemented in stages. Stage -
I would be for one year from April 1, 2003, to March 31, 2004 and Stage - II
would be for two years, from April 1, 2004, to March 31, 2006 while the
modalities of Stage - III is to be decided after review of the implementation
of the first two stages. There
would be six groups based on vintage and feedstock for determining the
group-based concession under the new scheme, namely, pre-1992 gas-based
units, post-1992 gas-based units, pre-1992 naphtha-based units, post-1992
naphtha-based units, Fuel Oil/ Low Sulphur Heavy Stock (FO/LSHS) based units
and mixed energy based units.Units in each group will be allowed concessions,
based on weighted average retention prices. The
concession rates of for the units in each group would be determined in two
steps. In the first step, the weighted average retention price and dealer's
margin of the units in the respective group as applicable on April 1 2002, is
to be computed. Units having exceptionally high or low retention price, i.e.,
deviation of 20% and above with reference to group average computed in Step-1
are to be treated as outliers in their respective groups. In step-2, the
final weighted average group retention price after excluding the outliers is
to be computed. Further
the units in each group would receive the concession after adjustment on
account of escalation/de-escalation in the variable cost related to changes
in the price of feedstock, fuel, purchased power and water. The department
will work out the modalities for this purpose for Stage-I and Stage-II on the
basis of group energy data and efficient consumption patterns of the units
keeping in view the data of the eighth pricing period. After
commencement of Stage-I and also beyond Stage-II, there shall neither be any
reimbursement of the investment made by a unit for improvement in operations
nor any mopping up of gains of the units as a result of operational
efficiency. Gujarat Narmada Valley Fertilizers Company Ltd. (GNFC) Gujarat Narmada Valley Fertilizers Company Ltd. (GNFC),
is a joint sector enterprise promoted by the Government of Gujarat and the
Gujarat State Fertilizer Company Ltd.(GSFC). It was set up in Bharuch,
Gujarat in 1976. Located at Bharuch in an extremely prosperous industrial
belt, GNFC draws on the resources of the natural wealth of the land as well
as the industrially rich reserves of the area. GNFC
started its manufacturing and marketing operations by setting up in 1982, one
of the world's largest single-stream ammonia-urea fertilizer complexes. Over
the next few years, GNFC successfully commissioned different projects - in
fields as diverse as chemicals, fertilizers and electronics. Since inception,
GNFC has worked towards an extensive growth as a corporation. A growth which
respects the environment and springs from the progressive vision of GNFC. GNFC
today has extended its profile much beyond fertilizers through a process of
horizontal integration. Chemicals/Petrochemicals, Energy Sector,
Electronics/Telecommunications and Information Technology form ambitious and
challenging additions to its corporate portfolio. GNFC has an enterprising,
strategic view towards expansion and diversification. GNFC has a diversified business model. Fertilizers
& chemicals account for 58% & 41% of total sales respectively. This
diversified business model helps it tide over adverse business conditions in
any particular segment. ~ It is the lowest cost fertilizer producer in the
fuel oil group. GNFC will continue to get the same retention price as it used
to get, under the new group based fertilizer policy effective from1st April
'03. The company is expected to the positively impacted in stage – III of New
Fertilizer Policy, when the low cost manufacturers are going to receive
incentives for being cost efficient. GNFC's ammonia plant has a capacity of 1350MT per
day while the average capacity of other plants of competitors is 900MT per
day, which offers benefit of economies of scale to GNFC for ammonia
production. It has adopted better
technology for ammonia production in order to reduce its energy consumption.
It uses Texaco process using two gasifiers as compared to Shell process using
three gasifiers used by most of the fertilizer manufacturers. The company is one of the largest manufacturers of methanol and
nitric acid in India having market shares of 37% and 56% respectively. Recently, it has expanded capacity of methanol and
nitric acid for greater market access. A section of its Nitrophosphate group
of plants has suffered an explosion on October 14, 2003 and the plant
operations have been affected but GNFC has full insurance cover for this
plant. GNFC's fertilizer plant is located in the state of
Gujarat having relatively lower irrigation facility. Company's fertilizer
plant is based on fuel oil and going forward company will have to switchover
to more efficient feedstock based plants because of increasing deficit of
fuel oil. Annexure I Profit and Loss Account (All
figures in Rs. crores)
Balance Sheet(All
figures in Rs. crores)
Technical charts of GNFC Moving Average Chart
Price Line 50-day Moving Average
Line B A RSI Chart C D MACD Chart
END OF SECTION D Section E : Caselets (50 Marks) · This section consists of questions with serial number 6 - 13. · Answer all questions. · Marks are indicated against each question. · Do not spend more than 80 - 90 minutes on Section E. Caselet 1 Read the caselet carefully and
answer the following questions: 6. The
caselet states that the SEBI will introduce margin trading and securities
lending scheme in the bourses from February 1, 2004. Briefly explain the
process of margin trading with an example. (8 marks) < Answer > 7. According
to the caselet, margin trading provides finance and improves liquidity in
stock market. Enumerate the advantages and disadvantages of margin trading. (10 marks) < Answer > In an
effort to make available finance and improve
liquidity in stock markets, the Securities and Exchange Board of India will
introduce margin trading and securities lending scheme in the bourses from
February 1, 2004, even as it expressed concern over sharp rise in sensitive index.
The corporate broking entities would be able to directly lend funds to
investors to finance their trading in cash market subject to certain
regulations while any person holding securities (shares) would be able to
lend them in market through stock exchange mechanism. “The Sebi board cleared
the proposals on Tuesday at a meeting in Kolkata and we will come out with
detailed notifications soon. We hope to commence working on the scheme from
Febraury 1," Sebi chairman G N Bajpai told reporters in Mumbai on
Wednesday. The facility of margin trading will be available only for stocks in Group-1 of the SEBI risk management system, which numbers at about 150. Securities lending and borrowing system enables any investor to approach the clearing corporations of the stock exchange to lend or borrow securities. Only Indian corporate brokers with a minimum networth of Rs 3 crore (Rs 30 million) would be permitted to run margin trading, he added. This is a step for development of the market, Bajpai said, adding the proposed margins trading and lending scheme did not have any resemblance with previous badla system as new mechanism would have strict disclosure standards. The new schemes would be reviewed after six months, he said. On the current status of the market, Sebi chief said the regulator had been keeping a close watch on the market and was concerned over the sharp rise in index movement. "Whenever we come across unusual movement in the market, we will take prompt remedial measures and punish those found guilty of breaching regulations, Bajpai added. Caselet 2 Read the caselet carefully and
answer the following questions: 8. The caselet states that periodic earnings announcements do serve a purpose as they reveal information that would give a fair idea of the progress of the company. Briefly discuss the non-financial factors to be examined by an investor to assess the progress of the company. (9 marks) < Answer > 9. The caselet states that
when making an investment decision, adequate discounting should be done for
any risks associated with the business. This would be based on the investor's
risk-taking ability. Do you agree ? Justify. (7 marks) < Answer > Periodic earnings announcements may not tell the
whole story but they definitely provide the jist of it.
These numbers may lead to higher or lower expectations and affect the
valuation of the stock. At times the management may also resort to
window-dressing to meet the forecasts. But does it mean that these numbers are
irrelevant? What information can you glean from interim financial reports?
Periodic earnings announcements do serve a purpose as they reveal information
that would give a fair idea of the progress of the company. Additional
disclosures, such as segment reporting, presentation of consolidated results
and the geographical break-up, give a lot of information that would otherwise
not be available in public domain at such frequency. Analyst presentations and
conference call transcripts are also available on certain company Web sites.
These are valuable sources of information and give insights into the
companies' operations and prospects. They give you a feel of what is
happening in a company and where is it heading in terms of business
performance. Periodic financial disclosures also show how the company
compared with its peers. They indicate a company's market position and
control within the industry in that particular period and also point to
whether a company has the potential to make the best of the given business
conditions. The absence of such periodic disclosure leaves a gap in financial
information. Worse, it could lead to selective disclosures, giving room for
insider trading. Small investors would be left in the lurch due to
non-availability of information. The market might witness wider swings due to
speculation and selective disclosure. Information provided in financial
statements is useful if scrutinized properly. For instance, the previous
eight quarters' earnings announcements would indicate the trend in margins
and earnings growth. Sharp deviations may require further scrutiny to judge
the sustainability. Any one-off instances having an impact on the
earnings should be eliminated. Also, one has to be aware of the external
factors governing the business and their effect on the earnings performance
in any period. When making an investment decision, adequate discounting
should be done for any risks associated with the business. This would be
based on the investor's risk-taking ability. It might also pay to take an
independent view of the stock without the market interest in a stock
influencing your decision. Any stock that commands a higher valuation than
its earnings can support will be vulnerable to volatility. Markets generally
tend to overestimate the earnings growth potential of certain companies or
get carried away by exceptional earnings announcements without looking at the
ground realities. Often, stocks zoom or slump after earnings announcements
and trade at valuations that cannot be sustained by earnings growth. It is
better to avoid a stock that commands high multiples when the business
environment is uncertain. Also, avoid momentum investing in such stocks. A
little bit of caution and reasoning could protect you from extreme downside
risks. But do remember that numbers are usually factored in the stock price
and should not be taken fully at face value. Future performance would depend
on a host of external factors. A fresh investment decision should be based on
the general business environment and the scope for business growth. Caselet 3 Read the caselet carefully and
answer the following questions: 10. According
to the caselet, historically, pricing in commodities futures has been less
volatile compared to the equity and the bond markets, thus providing an
efficient portfolio diversification option. Do you agree? Justify. (6 marks) < Answer > 11. The caselet says that it’s
a different kind of research that you will have to do if you want to invest
in commodities. There are no balance sheets to read, no quarterly results to
wait for, no dividend announcements to factor into prices. Discuss. (10 marks) < Answer > For
those who want to diversify their portfolios beyond shares, bonds and real
estate, commodities offer another option. But you need to
look before you leap Add a new investment option to your list: commodities.
Till some months ago, this wouldn’t have made sense. For retail investors
could have done very little to actually invest in commodities like gold and
silver - or oilseeds, for that matter. Reason: there was practically no
retail avenue for punting in commodities. All that’s changing now with the
arrival of four new electronic, multi-commodity exchanges, where you can
trade in commodity futures. Business cycle analyst and investment guru Marc
Faber predicts that the next big boom will be in hard assets (a.k.a.
commodities), not financial assets (good ol’ shares, bonds, mutual funds, et
al). In an interview he said: “Global economic recovery and the depreciation
of financial assets due to excessive printing of money will make commodities
appreciate in relative terms”. You now have an opportunity to find out for
yourself if that’s true - assuming you have the interest in finding out which
commodities will boom and which one won’t. It’s a different kind of research
that you will have to do if you want to invest in commodities. There are no
balance sheets to read, no quarterly results to wait for, no dividend
announcements to factor into prices. On the
other hand, like an Englishman, you will learn to appreciate the intricacies
of the weather and unpredictable government actions (What will frost in
Brazil do to coffee prices? Will the Russians sell more gold in the markets?)
Commodities actually offer immense potential to become a separate asset class for market-savvy investors,
arbitrageurs and speculators. The good news: historically, pricing in
commodities futures has been less volatile compared to the equity and the
bond markets, thus providing an efficient portfolio diversification option.
In fact, the size of the commodities markets in India is also quite
significant. Out of the country's GDP of Rs 13,20,730 crore, commodities
related (and dependent) industries constitute about 58 per cent. Currently,
the various commodities exchanges across the country clock an annual turnover
of Rs 1,40,000 crore. With the introduction of futures trading, the size of
the commodities market grow many folds here on. Like any other market, the one for commodity futures plays a valuable role in information pooling and risk sharing. The market mediates between buyers and sellers of commodities, and facilitates decisions related to the storage and consumption of commodities. In the process, they make the underlying market more liquid. Given the number of players involves - from producers to consumers to investors and speculators - the commodity futures market increases the speed with which new information is incorporated into prices. Retail investors who claim to understand the equity markets may find the commodities market a funny kind of animal. But commodities are actually more predictable once one understands the fundamentals of demand and supply and the factors affecting their prices. END OF SECTION E END OF QUESTION PAPER |
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Section D : Case Study Entry barriers are high in this industry due to uncertain government regulations and capital intensive nature of the industry. The industry is capital intensive, both capital-wise and working capital-wise. The investment for a minimum economic size urea plant (2,250 tpd) is Rs15bn. The investments for a minimum economic size capacity in DAP (1,500 tpd) and SSP (100 tpd) plant is lower at Rs5bn and Rs0.4bn, respectively. The working capital requirements of the industry are also high because of dedication towards imports (if using imported raw materials, generally the case in phosphatic fertilizers) and delays in the release of subsidies. Roughly, about 30-45% of sales is locked in working capital. This acts as a strong barrier restricting a smooth entry of new players. Central government Policy also directly influences pricing, production and distribution of fertilizers. This is apparent as demand for phosphatic fertilizers went down when prices of phosphatic fertilizers went up after decontrol. Retention Price System and other adhoc concession schemes make the pricing of fertilizers almost under control of governments. Moreover, Maximum Retail Price (MRPs) of fertilizers are also decided by the central government. Clearly, government regulations also act as big entry barrier to the fertilizer industry. However, undifferentiated products allow relatively easy entry to new entrants Bargaining power of Suppliers This is high since the main raw materials like feedstock, gas, has alternative uses in industries such as power and petrochemicals. Certain raw materials are imported from the foreign countries and those raw materials are important ingredient and therefore bargaining power of suppliers is high. Bargaining power of Customers The farmer lobby is powerful India because of central importance of the production of food crops in India. Government also supports the farmer by deciding the prices of the Fertilizers. Therefore, bargaining power of buyers can be said to be high in the fertilizer industry. Threat of Substitute Threat of substitute is low as there are no alternatives available for the fertilizers. Undifferentiated products do poses some threat to standardized product of the industry. For example, requirement of DAP is some time met by cheap urea. Although use of fertilizers in such manner is harmful to the production capacity of the land. Competition The competition is high in this industry as all the major companies are striving for higher market share.
Following can be inferred from above: i. Profit retention after tax had reduced in 2002 and picked up subsequently. This was because there was hefty increase in the tax in 2002 and 2003. ii. Profit before tax margin has increased throughout the period indicates better management of operations. iii. Asset turnover was very low in 2002 but increased till 2002 before declining slightly in 2002 . iv. The leverage TA/NW has increased in 2002 because of decrease in net worth and greater use of current liabilities (primarily provisions). As a result of above factors ROE has fallen in 2002 before recovering in 2003 b. Cash earning per share
=
From the above result it is very evident that cash earning per share of the company has declined in 2002 and then increased in 2003. Even earning per share is telling the same story. EPS has decline almost by 32% in 2002 although decline in CEPS is only 15.78%. The fixed assets are gradually increasing the depreciation change have also increased drastically but the fixed asset have got the potential to produce. CEPS are also providing a better idea of the cash available for use within company. Since depreciation is a non-cash charge. CEPS should be given preference to EPS when analyzing fertilizer industry because EPS discriminates against growing companies which have block of assets compared with companies which are growing slowly and therefore not investing in fixed assets. 3. Price using regression equation Beta = = 0.85 ´ Dividend Payout Ratio (%)
Average
Dividend Payout Ratio = = 46.81%. Growth Rate in Earnings
Average
Growth Rate = = 15.25%. ROE (Return on Equity)
Average
ROE = = 10.75% PRegression = 47.25 + (10.25 ´ 0.4681) + (25.45 ´ 0.1525) – (0.89 ´0.75) + (45.80 ´ 0.1075) = 47.25 +4.798 + 3.88 – 0.6675 +4.923 = 60.18 II. Price as per DDM The face value of GNFC share is Rs 10 DPS for the year 2003 is: 2.5. It is given that the earnings will grow by 20% for the next 5 years and 10% later. The required rate of return Re = Rf + (Rm – Rf) bi = 5.50 + (25.75 – 5.50) 0.75 = 5.50 + 15.19 = 20.69%.
P5 = Value at the end of year 5 = 64.6´ PVIF (20.69%, 5) = 64.6 ´ 0.3905 = 25.22 Price as per DDM as on 1.4.2004 = 25.22 + 12.87 = 38.09 P0 as on 1.4.2004 = 0.35 ´ 38.09 + 0.65 ´ 60.18 = Rs.52.45
4. a. At this point both moving average and price line has started rising it is an indication to buy b. Price line falls below a rising moving average line – so it does not indicate any trend reversal – the indication is to buy, to gain from the rebound in the secondary reaction. c. RSI has touched the overbought position and price decline expected , it is an indication to Sell d. RSI has touched the oversold position and price rise is expected, it is an indication to buy e. MACD indicator is almost merging with reference line so it is signal to hold the stock. 5. The leading indicators for the fertilizer industry are as follows: a. Agricultural production b. Export prospects of food grains c. Money supply d. Interest rates e. Corporate profits f. General level of stock prices Fertilizer industry is largely dependent on the growth of the agricultural production. Export prospects of food grain will also determine the requirement of fertilizers. Level of corporate profits may indicate increase in demand of goods. The performance of the fertilizer industry is dependent largely on prevailing economic conditions. Therefore, fertilizer industry will perform well, when the economy is either recovering or performing nicely. State of economy is indicated by the level of stock prices, money supply and interest rates. Caselet 1 6. Buying on margin is borrowing money from a broker to purchase stock. You can think of it as a loan from your brokerage. Margin trading allows you to buy more stock than you'd be able to normally. To trade on margin, you need a margin account. This is different from a regular cash account in which you trade using the money in the account. By law, your broker is required to obtain your signature to open a margin account. The margin account may be part of your standard account opening agreement or may be a completely separate agreement. An initial investment of at least Rs.2,000 is required for a margin account, though some brokerages require more. This deposit is known as the minimum margin. Once the account is opened and operational, you can borrow up to 50% of the purchase price of a stock. This portion of the purchase price that you deposit is known as the initial margin. It's essential to know that you don't have to margin all the way up to 50%. You can borrow less, say 10% or 25%. Be aware that some brokerages require you to deposit more than 50% of the purchase price. You can keep your loan as long as you
want, provided you fulfill your obligations. First, when you sell the stock
in a margin account, the proceeds go to your broker against the repayment of
the loan, until it is fully paid. Second, there is also a restriction called
the maintenance
margin, which is the minimum account balance you must maintain before
your broker will force you to deposit more funds or sell stock to pay down
your loan. When this happens, it's known as a "margin call."
We'll talk about this in detail in the next section. Therefore, buying on margin is mainly used for short-term investments. The longer you hold an investment, the greater a return you need to break even. So you see that if you hold an investment on margin for a long period of time, the odds that you will make a profit are stacked against you. Just as companies borrow money to invest in projects, investors can borrow money and leverage the cash they invest. Leverage amplifies every point a stock goes up. If you pick the right investment, margin can dramatically increase your profit. A 50% initial margin allows you to buy up to twice as much stock as you could with just the cash in your account. It's easy to see how you could make significantly more money by using a margin account than by trading from a pure cash position. What really matters is whether your stock rises or not. The investing world will always debate whether it's possible to consistently pick winning stocks. We won't weigh in on that debate here, but simply say that margin does offer the opportunity to amplify your returns. The best way to demonstrate the power of leverage is with an example. Let's imagine a situation that we'd all love to be in--one that results in hugely exaggerated profits: We'll keep with the numbers of Rs.20,000 worth of securities bought using Rs.10,000 of margin and Rs.10,000 of cash. Trademark Co. is trading at Rs.100 and you feel that it will rise dramatically. Normally, you'd only be able to buy 100 shares (100 x 100 = Rs.10,000). Since you're investing on margin, you have the ability to buy 200 shares (200 x Rs.100 = Rs.20,000). Trade mark Co. and the price of shares skyrockets 25%. Your investment is now worth Rs.25,000 (200 shares x Rs.125) and you decide to cash out. After paying back your broker the Rs.10,000 you originally borrowed, you get Rs.15,000, of which Rs.5,000 is profit. That's a 50% return when the stock went up 25 Rs. Keep in mind that, to simplify this transaction, we didn't take into account commissions and interest. Otherwise, these costs would be deducted from you profit Disadvantages
: It should be clear by now that margin accounts are risky and not for all investors. Leverage is a double-edged sword, amplifying losses and gains to the same degree. In fact, one of the definitions of risk is the degree that an asset swings in price. Because leverage amplifies these swings then, by definition, it increases the risk of your portfolio. Returning to our example of exaggerated profits, say that instead of rocketing up 25%, our shares fell 25%. Now your investment would be worth Rs.15,000 (200 shares x Rs.75). You sell the stock, pay back your broker the Rs.10,000, and end up with Rs.5,000. That's a 50% loss, plus commissions and interest, which otherwise would have been a loss of only 25%.Think a 50% loss is bad? It can get much worse. Buying on margin is the only stock-based investment where you stand to lose more money than you invested. A dive of 50% or more will cause you to lose more than 100%, with interest and commissions on top of that. In a cash account, there is always a chance that the stock will rebound. If the fundamentals of a company don't change, you may want to hold on for the recovery. And, if it's any consolation, your losses are paper losses until you sell. But as you'll recall, in a margin account your broker can sell off your securities if the stock price dives. This means that your losses are locked-in and you won't be able to participate in any future rebounds that may take place. 8. The important non-financial parameters to be examined by an investor are as follows: Business
of the company The investor should know whether the company is a well-established one, whether it has a good product range and whether its lines of business have considerable potential to grow. Top Management
The quality of top management team, particularly, the competence and the commitment of the chief executive officer matters a lot in shaping the destiny of the company. Product Range
Progressive companies like ITC and Hindustan Lever create competition for their existing products by launching new products with regular frequency. Hence investors must examine whether the company under review belongs to this group or not. Diversification
An issue related to that of product range is diversification. To reduce the degree of business risk and improve profitability, many companies resort to diversification. Hence this issue is to be carefully examined by the investor. Foreign Collaboration
Where a company has entered into technical collaboration with a foreign company, the investor must find out more about the nature of the collaboration agreement. Availability of Cost of Inputs
If the company depends upon imported raw materials, it is important for the investors to assess the raw material position, because any shortage of the raw material and/or escalation in the cost of raw material will adversely affect the profitability. Research and Development
Progressive companies spend substantial sums of money on R&D to upgrade their existing products, introduce new products, adapt foreign technology to suit the local conditions, achieve import substitution, etc. Governmental Regulations
The investor must assess the implications of governmental regulations such as MRTP Act, FERA, etc., for the company under review. Pattern of Shareholding and Listing
The pattern of shareholding has a bearing on the floating stock available in the market and the trading volume of these issues will have an effect on the company, hence it will be analyzed by the investor before taking any investment decision. 9. The statement is very true as discounting factor used for discounting return takes into account of risk attached with business entity, which in turn depends on risk tolerance capacity of the investor. The required rate of return consists of two component risk free rate of return and risk premium. The risk free return component changes as and when real risk free return and inflation rate changes. Risk associated with any particular business is factored in the risk premium component. For example if the firm is more risky than an investor willing to invest in the company would be asking more return in the form of more risk premium. The amount of risk premium would be decided on the basis of risk taking capacity of a an investor. For the same amount of risk a risk averse investor would be asking more return compared to his counterpart who is risk loving. Hence it is perfectly correct to say that t when making an investment decision, adequate discounting should be done for any risks associated with the business. This would be based on the investor's risk-taking ability. Caselet 3
10. It is very much correct to say that historically, pricing in commodities futures has been less volatile compared to the equity and the bond markets, thus providing an efficient portfolio diversification option. The primary asset allocation categories are: stocks, bonds, and cash. But other categories are sometimes mentioned as possible candidates—in particular gold, real estate, and commodities. For the most part, these assets are thought to provide portfolio protection from severe economic conditions. Gold is usually viewed as the asset of choice in times of total economic chaos. Precious metals, commodities, and real estate are viewed as hedges during highly inflationary time periods. Typically the returns provided by the commodities are low but steady and therefore provides balance to portfolio return in turbulent time when normal investment categories are not performing well. One big reason for selection of these assets in portfolio for portfolio diversification is lower correlation of the commodities with stocks bonds and other securities. Now definitely these other assets really bring another dimension of diversification to a portfolio. And hence for achieving diversification benefits it is possible for individuals to. effectively invest in the commodities. 11. The caselet correctly mentions that a different kind of research you will have to do if you want to invest in commodities. There are no balance sheets to read, no quarterly results to wait for, no dividend announcements to factor into prices. Actually, while evaluating commodities the important things to be looked into is the factor which affects their price which defines the risk and return attached with the commodities. In the post-World Trade Organisation (WTO) era, the entire agricultural produce market moves primarily on the basis of climatic factors (including the monsoons), various government actions (subsidies, market support prices, etc.), and international agricultural trade pricing and policies. In non-agricultural commodities - especially gold, silver, and non-ferrous metals - the factors influencing prices could include global production, mining, hoarded stocks, tariffs and taxes, among other things. WHAT
IMPACTS COMMODITY PRICES Agro produce · Vagaries of monsoon · Changes in national exim policies · Changes in farm support prices (subsidies, minimum support prices, etc.) · Storage and transportation cost · Changes in the sales tax and central tax structure · Imposition of anti-dumping, non-tariff measures at both global and domestic level Bullion · Changes in the policies of official sector gold sales by global central banks · Changes in international hedge book position · Change in the country’s policy for importing gold · Change in tax structure Metals · Change in the mining and exim policies · Imposition of anti-dumping, non-tariff measures at both global and domestic level · Change in tax structure · Changes in the manufacturing activity · Corporate actions |
