Introduction to February Issue

Recession in an economy is like winter time. Trees are shedding dead leaves. It’s difficult to see a green patch. The well adapted animals have gone into hibernation. The less fortunate ones are braving the chill. If there is anything that’s left smoldering…it’s the question of survival.

Survival, is the key theme of this issue of unfair value. On one hand, you would see how investors are losing their precious dollars in an economic activity called trading which produces no value for the economy. You would also see how the corporations have jeopardized their survival in an effort to hedge their risks.

The things are quite bad. In India industrial output is shrinking, overall growth his slowing down. The fiscal stimulus provided by government has resulted in record fiscal deficit which is pushing the interest rates higher, nullifying the positive impact of stimulus.

Amid all gloom, I’m smelling opportunity. Of making money? Heck, no!The downturn brings an opportunity to learn like never before. All you need is – two open eyes, two open ears, one functioning brain and some free time. If you are planning to stop the business newspaper at your home as a cost cutting measure, don’t. You can stop buying the Times of India instead.

So the class begins.

The most interesting thing to observe is the change in consumer behavior during uncertain times. The consumers are the intelligent economic agents at the bottom of the economic food chain and thus decide the fate of everyone above. They react to uncertainty about future income by cutting down costs. In each product category, there are multiple price points available. Rather than stopping the consumption altogether, the consumers tend to shift to lower price points. Some producers gain from this downgrading at the expense of others.

The producers of goods and services are also intelligent agents. They react to this shift and take actions. Their actions cause further reactions from consumers. The real estate market in Bangalore is an example. When the slowdown hit the real estate sector, the builders were sitting on a huge inventory of homes already built or under construction. They were reluctant to bring down the prices. Why?

Let’s say, a buyer has paid only 5 lakh Rupees as booking amount for a flat priced at 80 lakh. If the developer reduces price by 10%, the buyer has an incentive to forego his booking amount and buy another flat at a discount. So the builders kept waiting even though their sales fell, as much as 70% to 80%. The builders were heavily leveraged which reduced their capacity to hold on to prices forever. Then came the wave of new project announcements at the lower end of the market which offered, so called budget housing (whose budget they fit into??). The falling prices of land and construction materials helped. Finally the cookie crumbled. DLF announced a cut in prices in Bangalore. Now guess what would happen next? Amid all this, the myth in the consumers’ mind that the property prices never go down, has been shattered. That’s going to affect the investment demand from wealthy consumers, for the second home that they never needed. And it’s quite easy to see that in a country where 5 lakh per annum is considered a good salary scale, even the so called budget homes are not within the budget of most of the people. At Infosys, less than 0.5% employees earn more than 2 lakh per month. A person earning two lakh per month (gross) will end up with around one lakh rupees per month as the take home salary. If he saves 40,000 rupees a month, the price of 40 lakh for a home represents more than 8 years of his savings.

Well, the picture does get gloomy. Talk of real estate makes me feel nauseated.
Change of topic. Read this headline[1].

Two are self explanatory…let’s talk about telecom. The Economic Times reports that 99% of new mobile connections in India are pre-paid. This is interesting. From accounting for about 60% of the country’s total subscriber base in 2005, pre-paid users now constitute over 92% of India’s mobile customer base. It’s quite clear that consumers want to put an upper limit on everything that costs money(except stupidity). At the same time, our mobile phone user base is increasingly being dominated by people from the lower income group – which, in my definition includes children of rich dads with zero income. The consumers (or their rich dads who are paying the bill) have strong reasons to cap the expenses but at the same time it is a cost effective and zero default segment for the telecom companies which assures steady minimum revenue.

Ok..Look at this picture unsold cars of Nissan stored around the factory's test track[2].

I was very surprised when I saw this. For years, we have been hearing about just-in-time manufacturing by auto companies like Toyota. What happened? The description of their Just-In-Time production system from their site reads: “Making only what is needed, when it is needed, and in the amount needed”.

How did they end up with so much inventory?

Further search took me to an article[3] titled Toyota, Honda May Scrap `Just-in-Time’ inventory as `Supplier Shock’ Looms. Apparently, when the demand fell and automakers stopped issuing orders to their suppliers for parts, the suppliers were on the verge of bankruptcy. When the demand comes, if you don’t have any suppliers left to supply you the parts, how will you produce the car just in time?

The other problem is that of scale. Each model of car requires a certain minimum units to be produced to be profitable. If you are selling 250 units a day, it’s ok to produce 200 units some days and 300 on others, based on variation of demand. But you cannot profitably produce just 10 units a day in your state-of-the- art plant that cost you billions of dollars.

You can see the kind of surprises the downturns throw upon us and to the extent we overestimate our capability to comprehend complex symbiotic relationships between economic agents and the shock waves of impact that travel at lightening speeds.

I feel humbled by the phenomena that I can not explain or account for. This has always been the driving force being my quest for knowledge. I’ve presented a few cases to you but if you start your day with a warm cup of tea and a business newspaper, you will have more fun and we at UnfairValue will always love to be part of your quest for answers.

The value of the art of fishing is always more than the monetary value of the fish that you are offered in all cases expect when the fish you are being offered is the last fish of the once abundant seas. The investing world is swelling with fishes. It’s about time we stop searching for a hot tip about a stock that’s going to shoot through the roof. It’s time to learn fishing.

1. Telecom, liquor keep the spirits high
Economic Times, 25 Dec 2008

2. Growing stocks of unsold cars around the world
Guardian, Jan 2009,

3. Toyota May Modify Just-in-Time to Ease Supplier Shock
Bloomberg, December 29, 2008


Unknown said...

Hey KP great stuff..keep up writing Buddy! Cheers!

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