CoVid Lockdown Impact on FMCG

Neil George – MD, India and South Asia NIVEA
(ex-P&G, and many other FMCG companies in India and Overseas)

Though FMCG was part of essentials. All malls were shut. Online channels could not sell. So there were demand side issues

Supply side issues
After lockdown, most factories went into a shutdown.
Most warehouses also went into shutdown.
90% of shops were shut down during lockdown 1 and 2

So, every company had to start from scratch. Had to go to authorities and get approval. Large companies had resources. But most medium and small companies could not afford to get approvals from various authorities in many towns and districts. One had to get approval in each town separately where the company had operations.
80% of retailers had supply challenges. Most kirana were sourcing supplies at higher prices from wholesalers.
Shortage of staff -  25% of retailers in urban India said staff did not turn up.
100% had startup and staff issues.
50% had production capacity issues.
50% has cash flow issues.

Demand side contraction
Food and staples demand were stable. Some parts in foods like candies, chocolates, cigarettes, alcohol etc were not allowed to sell and in some categories number of stores were not open.

Net net, overall market data from Neilsons shows a steep demand decline. Spread uniformly across urban and rural.
April - FMCG demand down by 34% y-y and 37% m-m. Unprecedented in history of India.
Metro -  (32%) y-y
Semi urban – (39%) y-y
Rural – (31%) y-y

Biggest contraction was in the West.
West had the largest number of containment zones. In addition to metro cities like Delhi, Gurgaon, Chennai.
Categories impacted the most - where people would have to travel outside their homes.
E.g candies, perfumes, soft drinks, cosmetics (not going to work, colleges, marriages etc), hair oils, confectionaries, agarbatties.

Categories that did very well
Cooking oils, dairy products, spices, snack categories, diapers, body washes detergents

Crisis itself differentiated companies that did well and that which did not do well

Portfolio of companies and where they were selling - say Amul, Nestle’s dairy products.
Food companies did well as they were essentials.
Portfolio  where a large part of business was from Malls - large Retail with shops in malls, were severely impacted as malls were shut.

Down trading from premium products. - Hair oils.

Where companies had large inventory with retailers, their sales were affected.

Present scenario
In June - supply side disruptions are fewer. Most factories are up and running.
Problem is staff coming back. In many places, staff movements across states are significant.
e.g in Baddi in HP - employees travel from different state to work.
In many places , temporary staff keep coming in and out. Migrant labour issues.
More or less 80-90% capacity is back. Some variances are there.
Stores and distributors are opening up. So supply chain is restored. Except where there are imports and exports.

Demand side is where problem lies.
In some categories like foods,   Demand is more or less back.
Non food sectors, still a problem. People are not going to offices, colleges are not on, people are not walking around – cigarettes, alcohol, soft drinks, beverages still significantly impacted.

Demand has shifted from large stores to smaller stores.
Movement to ecommerce is happening in a big way. Flipkart, Amazon, Nykka, Jio has expanded their on-line models to 200 cities.
DMart - also seeing on-line delivery going up.
Swiggys, Zomato, Dunzo seeing large increases.

When will things come back to normal?
Lot of retailers will have cash flow problems.
Will see enhanced M&A in the industry as many small companies will shut down owing to cash flow problems.

Categories
Bar soap Rs15,000cr
Detergent
Shampoos and Hair oils
Dairy
Beverages

FMCG growth tends to be 200bps above nominal GDP growth.
Lower for categories that have high household penetration.
Bar soap is 100% penetrated. Category growth is 1 1/2 -2%. However, shower gel and body wash are growing at 60-70%. But very small category as of now.
Premium detergent - higher growth.

Growth this year
Essentials - will come back
Non essentials - will have a big problem.
Seasonal category company  - soft drinks - huge problem of lost sales.  winter categories company will have less problems.
Inventory holding companies - low inventory cos will have less of a problem. Large inventory holding cos will face lot of problems.
Cos with out of home consumption will have problems. Like beer, cigarettes, soft drinks, camdies, chocolates etc.

Worst hit companies -
Non essentials are  a big part of your portfolio, large summer consumption, and out of home consumption.
Beer, aerated drinks, candies (most of these companies have an expiry date of 3 months)
You will see a lot of inventory writeoff in current quarter.

Private labels -
FRL,  D Mart, Reliance have private labels for selling in their stores.
FRL had sole licenced several domestic and global brands. Now the original brand owners are looking for alternate owners.
On the online space, Cos like Amazon, Flipkart, Big Basket, they are looking at lots of food brands.
Private label does very well under 3 conditions.
Category has to be very large.  Very few categories can be created by private label brands.
No innovation required -  like toilet paper, packaged foods, Plastic bags, etc.
Brands where brands are not playing in different price points. Private label guys will come at the Lower end of the market.

Fairness creams - 
Fairness creams came up in 1975 in India. Today the category is Rs4000cr category today,
Picked up in India, and countries like Indonesia because of our love for our colonial masters. Fair color.
Also started to be used by men. When Emami launched its fair and handsome in 90s, Men’s fairness creams became a large category as they were earlier using their wife’s fairness cream. People were also using it as moisturizers.

Last two years, new generation is against fairness creams because of social media campaigns.
Last 18 months, almost every big brand ambassador  is refusing to endorse fairness creams.
Now many companies are relaunching and rebranding these creams under different category.

Last week, Johnson and Johnson has decided to completely stop sale of this category.

Importance of ancillaries in FMCG
Different for different categories,
In premium skincare, raw material cost is a small percentage of its cost. Packaging sometimes smaller than raw materials.
In many cases, there is no single ingredient that dominates the raw material costs of the company.
Suppliers can be changed quickly.
Power of suppliers in skincare is limited.
Only exception is fragrance providers. This is the only attractive segment among suppliers.
Firminish and Zuvidan (Swiss owned) . They typically have 80% gross margins.

For many categories, demand will be back on track in 2021 and start to grow in 2022.
Because of our demographics, our market will continue to be strong.

Pricing of products in different emerging markets - mostly comparable prices across emerging markets for a similar products.
In some cases, product premiums may be different.

Default rates with distributors
India has large number of distributors for FMCG. They can be very large and cover a large territory.
Have a clear distributor ROI model. 18-24% ROI almost guarantee. Parent company will force you to be lean and mean.
If you are a local distributor managing small brand and territory, will be impacted in a post Covid scenario. First and second batch already happened in demonetization and then GST. Now the third crisis will unfold. Already saw 25% small distributors shut shop.
Another problems will come for consumers going online. Then you don’t need distributor model. You need only delivery models.

Small stores - lots of them are small family stores. No rent, or employee cost. Family run. They get credit and will survive.
Middlemen will face maximum problem as their operations are inefficient.

What happens to wholesalers?
Digital has impacted industries where there are lots of middlemen.
Say Real estate - builders, agents, . Directly connecting buyers and sellers.
Wedding brokers - all dead.

Disintermediation of inefficient channels - happening across the world.
Crisis will accelerate these shifts.

Companies that are best placed to do this
Companies starting from scratch. ID Foods, Paper Boats,
Bira - Amazon has got license to sell liquor in W Bengal. So can go to Amazon and sell liquor.
New age companies which don’t have a costly infrastructure can go  and sell their products easily to ecommerce channels.
Amazon - marginal cost to deliver a product is Rs35-50 per package.
So companies that have large selling prices and ship something in small quantities will fare best. Say Rs500-1000 with size of say a 1 liter of water. Such companies will,succeed.
Personal. Care products, watches can succeed very well in online sales.


Organic products or Naturals
Biopic Rs1500cr
Kama ayurveda Rs400-500cr

Ayurveda is a part of the categories.
Ayurvedic space is a very large area where consumer growth is likely to be high.

Innovations
New categories which use no color or chemicals.
Most innovations in personal care comes from Korea.
Celebrities have been launching their own products.

Delivery models -
Subscription models - Razor company in the US. Also for diapers.
Specially targeted at individuals - makeup. You can send your skin color online and you can get it 3D printed and collect it from the store or get it delivered.

Reliance Retail –
large conglomerates business
Reliance Fresh
Reliance cash n carry

Playing in 3 areas
B2B, B2C and B2B2C

1. Kirana store - give a POS machine, manage inventory and supply them inventory. Testing outside Mumbai last one year.
From May 15th - Jio app. Works in 200 cities.
2. Order online. Stock gets licked from their shop and will get it delivered. Have teething problems and will get sorted out
3. Currently team of FB and Reliance team. Can place orders through WhatsApp. 

Over a year, these three models will get integrated.

Can Industry get squeezed by dominant players?
Online Amazon and Flipkart are already very big. Reliance can catch up with them.
DMart
So will have a 4 player market.  See 5-10 years before this market consolidates.

Why no large players entering the Dairy market against Amul like in other parts of the world.
Infrastructure setting up is very difficult.
Dairy is a very local business because of shelf life. So amount of time to take from supplier to consumer has to be very efficient.
Also dairy is a commodity business. Not much pricing power.
Apart of butter, none of the other categories have become big category. (Besides Milk). Amul has sales of about Rs1,000cr excl milk.

Opportunities in Distribution and ecommerce
Ocado  UK company. Moved from. Grocery sale company to providing technology to Ecommerce companies.

Consolidation of the logistics space.
95% of trucks are individual owned.

Ecommerce space - warehousing, crates.
Packaging innovation. Lots of wastage in packaging of Ecommerce products. Need to look at reusable packaging. It will wipe out bubble wrap and cellophane amd corrugated box industry.

Sugar Study by Vivek Saraogi, MD, Balrampur Chini Mills

Ethanol

When cane is crushed, we get bagasse which is the powdered crushed cane, molasses is a by-product of this process. Molasses is used in a distillery. It is distilled and dehydrated to get alcohol. First stage of alcohol we get is rectified spirit (96% purity) used in medicines, sanitisers and pharmaceuticals (all medical applications). Next stage of alcohol is ENA (Extra Neutral Alcohol) which is a better version of the rectified spirit. ENA is bought by all liquor companies (potable applications). Then if you dehydrate and refine the molasses more, you get ethanol which is rectified spirit (99.8% purity). Ethanol is physically blended with petrol. It can simply be poured into the petrol tank and it would be blended in the ratio of 1 litre of ethanol for every 9 litre of petrol. Mix varies from 4-10% of blending.

To make domestic sugar companies viable, you have to provide right selling price for sugar sale, ethanol sale and power price as subsidy. Cane price is the main raw material cost. For OMCs, pricing is done by getting blended cost of ethanol and petrol and charging the same to their customer. Lower crude prices will reduce ethanol in the mix and vice versa. Thus, price of crude affects the mix and eventually demand for ethanol.

Due to lack of distillation capacities in many states, blending here is still 5% while the ones with good capacity are blending at 10%. So national average blending is 5% currently.

Government now allows sugar companies to make ethanol directly instead of getting molasses through the sugar manufacturing process and then making ethanol.

B Heavy – Molasses loaded with sugar. So, this is the sugar being converted into ethanol. Government given a different price for this which is Rs.10 higher than normal molasses (by product) because you are sacrificing converting this into sugar. This sugar would be otherwise exported and subsidy could be claimed by company. What government saved in subsidy, it provided by giving higher prices and increasing mix.

When sugar prices are low, companies make more B Heavy, when sugar prices are higher, they make more sugar.

Government put restriction on the price below which sugar can be sold and quantity that can be sold. Surplus can be exported.

- Vivek Saraogi, MD, Balrampur Chini Mills via NBC Webinars

Indian Solar Business

Information on Indian Solar business provided by Mr. Mahavir Poddar who has a good experience and understanding of this sector:

Chinese government not allowing Chinese companies to set up component factories in India.

Solar panels are made of following components –

1.     Solar cells – 55% cost component. Cells are made from wafer – Poly ingots – poly silicon. This is key component for panel. India has about 2 GW capacity for cells. Nil capacity for wafers, ingots and poly silicon, most of it coming from China. Waferis just slicing of poly ingots by wires. Poly ingots is a furnace srt up wherein the poly silicon is melted and made into small ingots.

2.     Solar glass – 10-15% cost component. India has anti dumping duty on glass

3.     Aluminium frames – 10-15% cost component. India has huge AI reserves and building material section company. But only 1.5 GW of solar section. Rest being imported from China.

4.     EVA and backsheet  together comprises of 10%+ cost component. India has sufficient capacity but many Indian factories closed due to mainly price and also quality issues.

5.     Junction Box – 7%+ cost component. Few factories in India now. But still 50% being imported.

6.     Welding wire and consumables – Remaining % of cost component. Mostly imported

Glass price currently is Rs. 350 per sqm. 1 panel is approx. 330 wp and consumers approx. 2 sqm.
Main 95% market for Solar glass is regular 3.2 mm. Borosil Renewables made the world’s first fully tempered 2 mm thick solar glass with lowest iron content giving highest glass efficiency and removed hazardous substance “Antimony” from its solar glass.

Chinese cells prices are approx. $0.27/pc vs India cell prices of $0.55/pc for a 4.55wp. Domestic cells prices are 1.8 times imported cells.

Deepak Parekh Webinar

Current Scenario – Analysis & Business Response

1. Conserve, Cash at all Costs, you will need it for unforeseen circumstances, including another lock down

2. Make Team A & B. Team A studies, prepares current response, and Team B works on situation after two years.

3. You will have to increase wages for some workers to incentivize them to come back. Getting people back will be a problem

4. Travel sector will be hit for a very long time. 2 years plus.

5. 9 Months of this year will be gone in recovery in normalcy in terms of Operations coming back to normal. If there is no other pandemic.

6. Cut Costs, Reduce Salaries, Prune Manpower if needed.

7. Increase equity in the company. Better to be over capitalized is better than to be over leveraged. Being Over leveraged will be a disaster, avoid the debt trap at all costs. Give a discount, let investors make money. Get Private Equity. Singapore Airlines is doing a Rights issue as we speak.

8. Micro finance will be worst hit, amongst NBFCs.

9. Build relationship and trust with the banks. Don’t move relationships for a quarter or half a percent.

10. Await announcement for MSME. More incentives and support expected.

11. Real Estate: Land is a state subject, Real Estate Prices will come down by 20% at least. Developers who have bought land at high prices will to take a hit on the projects. Many companies will go bankrupt. MCHI – Credai must talk to the Govt for a one time restructuring like in 2008. It will take 8-9 months for things to normalize for Real Estate.

12. Payments from Govt is a big issue. Lot of litigation Macroeconomic Factors & Risks,

Long term Outlook:

1. Govt has agreed to increase Fiscal Deficit which is a good sign. State Govts getting Overdraft facilities from Central Government.

2. Consumer Credit is 13% as a percentage of GDP, where as China is 40% and USA 80%

3. Mortgage to GDP, India: 10%, China: 26%, Thailand 20%, Scandinavia: 90% USA: 70%. India needs to reach the 12-15% mark in the coming couple of years.

4. Yes Bank on Path on recovery, Should have taken part in a similar manner for ILFS and Jet Airways.

5. USA 10 year paper is 0.77%, India is 6%. India is at a BBB (Lowest Investment Grade). If we get graded down we will become a Junk Bond .This will crash the economy. This is also why it will be difficult to print money.

6. Interest rates will go down further, but Banks must pass it on to the company. RBI lends only to the Banks in India and Banks are concerned more about their own Balance Sheet than national interest. RBI must start buying Company Bonds.

7. Middle-East will be in a big trouble. Oil will not go back to 60-70. Oil will be at 40-50.

8. Expect more deglobalization. European countries have already made it mandatory for Govt approval for all acquisition, as companies are available cheap and there is a fear that China may look to take over companies in Europe.

9. Rupee will be under pressure. Look at a minimum 3% depreciation YoY of the rupee even in the best times. We are doing much better at the moment with 10% depreciation (Many are at 25%). Trouble will ensue only if our rating goes to Junk. Our Rating unfortunately has not gone up even in our Best Years of 8% growth. However, Companies are getting good borrowing rates. Exports will have to grow for India to do better. Expect a package for Export soon from the Government.

10. By 2023 390 million people will come into the middle class. Hence investment will come. Only 2% of Indians are invested in Equity. Equity investors will increase. India Mutual fund to GDP ratio is 12% where as in Mexico etc. are 60% plus and USA 100%. India needs to move to 20%. Rising middle class will lead to more investments in Real Estate and Equity in the long term.

11. Savings rate in India is 17% (Earlier 30%). 10% out of that is in Real Estate or Golds etc. Liquid Savings rate is 7%. People in India are getting used to consumption in India. So there is no stress there. Hopeful that consumption will increase.

12. EPFO should be allowed to invest in equity. They invested in IL&FS and made a loss. So it is more conservative.

13. There is a medicine (Cure) which is under testing in the USA, which hopefully should be out in the market by June end if FDA approves. Vaccine (preventive) will take time.

Measuring short term liquidity

The short-term liquidity or cash position of a company play a significant role in determining its financial health. Short-term liquidity, also known as working capital, is critical for day-to -day operations. It’s determined by the nature and size of business, seasonal variation in sales, change in input or raw material prices and length of the production cycle.

Analysts use different ratios for analyzing the effectiveness of the working capital management and one of such ratio is the cash conversion cycle (CCC).

CCC measures the lifecycle of cash and estimates the number of days in which a company can convert its resources into cash. It is derived using three sub-ratios—days inventory outstanding (DIO), day sales outstanding (DSO) and days payables outstanding (DPO). All three sub-ratios are also expressed in the number of days.

DIO measures the days in which a firm converts its inventory or raw materials into sales. DSO determines the number of days in which a company collects money from its customers for the sales made on credit. Often a company also purchases raw materials or inventory on credit which creates payables outstanding. DPO measures the number of days in which the company is required to pay its suppliers for purchases made on credit. CCC is calculated by subtracting DPO from the sum of DIO and DSO.

Lower the CCC, the better it is, as it implies that the company’s resources are locked into inventory for a lesser number of days. Consequently, it is less dependent on borrowed money for running day-today business operations. The lower ratio is also indicative of strong cash flows and improved liquidity. On the other hand, high CCC levels over a period of time requires investigation as it implies a slower inventory to sales conversion process.

Important metrics to use for PMF

Q. What is PMF?

A. Product market fit, when you hit the right fit with the market or when consumers accept your product, it’s basically getting consumer love. It essentially says your product has a market. Studying customer obsession, delight, satisfaction is important, but first you should know if the product has a market that means it has customers.

10 delighted people is better than a 100 happy people, especially in the early stages. At a seed stage startup, if I am the entrepreneur, I want to measure one thing: are people happy or delighted. Not satisfied.

Important to see the net promoter score (NPS) and then see the customer satisfaction score (CSAT). One is about virality and the other is about satisfaction. And it gets you repeat business. So basically what one should focus on is if people are happy with the product and therefore the product will get word of mouth.

Different businesses, for example even B2B businesses, SaaS businesses, every business by definition has customers. There is no difference - there may be nuances on how one measures in each case, but here is no difference in NPS and CSAT. It is what it is. Are my customers happy or delighted?

After that when I have reached that where I feel, okay, I have a set of people and I am going to get word of mouth, tongue in cheek I am going to say now, are people going to put their money where their mouth is. You can give things away for free and people will be delighted. The next phase which is post the series A phase give or take is with this objective: are people going to put their money where there is mouth is?

Now how to measure that? There are multiple ways. So, one of the core metrics which we have discussed before also is cohorts. But cohorts at this stage one needs to look beyond just usage cohorts and also look at spending cohorts. If I have really hit delight with some customers, not only should they be buying repeatedly with me but hopefully over a period of time they are buying more and more. In the first month, they may buy once. Second month, they will buy twice. And they are spending more and more money. That is one of the earliest foundations.

A negative revenue churn is when the company does nothing, their existing customers keep spending more and more, and the business keeps growing. So these metrics are not just for consumer businesses, they apply everywhere. And I would call the second phase more of spending cohorts.

Third phase is if there is a business model with which the company can make money doing that? And in the third phase you start looking at unit economics, how much does it cost you to acquire a customer, how much is their lifetime value.

At the second phase, we would think about some level of margin even though when we were looking at spending, we would have said what is the gross margin of the product? What is the basic cost? If you are selling below your cost, it’s a problem.

At the third stage, since you have to look at it more as a business, you have to start looking at contribution margin. And if all these things start firing, you will see it becomes a profitable, scalable business. I think that’s really the core of how one should think about it at different phases.



Q. As a founder, it’s always easier to spread yourself wide and try tracking all that you think is relevant for your business. But, should you set a limit? And then, prioritize the number of metrics to track? And within this are there specific metrics that are indicators of your company’s health like indicators for performance, growth, product improvisation something on these lines?

A. If used incorrectly this science can hurt you as much as it can help you. Example, on an ecommerce site’s last page after the payment, it asked a NPS question: “How likely are you to recommend this to others?” I have not received my product yet. So, what are they measuring? That’s A. B That is not the place to ask NPS. That’s the place to ask a CSAT question to say how was your website experience. It’s an ecommerce site. I haven’t received my product.

By the way, it doesn’t let me ignore that question. So now whatever I clicked and submitted is noise not signal. And people may be taking actions on that. So, it extremely critical to understand which metric is relevant where. On prioritization of these metrics give or take maybe five metrics or six metrics that can define any company: NPS, CSAT, gross margin, contribution margin, and finally the EBITDA. Now there is return on capital.

Less is more. Think carefully about if I could measure only one thing it may be too little, but two or three things that are most important. That’s number one. Number two, how and where you measure, it’s almost more important than what you measure because you may end up otherwise making wrong decisions.

Number three, people can tend to get buried - again to your question on measuring too many things, measuring them at various deep stages. Thinking of it top down to say what is the architecture of my business. If I am an ecommerce site, this is the architecture. If I am a SaaS site, this is the architecture of my business. And in each piece of that architecture at the top line level, at the midline level, at the bottom line level, can I pick one or two metrics? And, at the operating metrics level which gave me a sense of the health of the business.

Finally, very important, I think most companies that measure statistics themselves likely err on the side of being more positive than the reality. And so, I am a big believer and I often advised founders that always have third parties. Do outside in surveys, mystery shopping, and even NPS scores. For example, I have seen gaps of 20 points between what a company reports and then if a third-party diligence is done or a third-party survey is carried out on what is reported.

Where you are measuring, who you are measuring with. If you are measuring with your own customers, how do you know who has lapsed out because they weren’t happy and how are you measuring, then the real satisfaction which is why companies own surveys tend to be always overstated because the people who are really unhappy and who went away are no longer in the measurements by definition. So that’s critical.

Like I said, the best thing to do measure fewer things, make sure you are measuring them at the right place and at the right time. And third, triangulate with a lot outside in data.

Indian Media And Entertainment

The Indian media and entertainment (M&E) industry is expected to grow at a compounded annual growth rate (CAGR) of 10.5% to touch $45.1 billion by 2021 from the current $27.3 billion, said a report ‘Global Entertainment & Media Outlook 2017-21’ released by consulting firm PricewaterhouseCoopers (PwC).

While the Indian M&E sector will grow in double digits, globally the industry is projected to grow at 4.2% CAGR, according to the report which covers 17 media and entertainment segments across 54 countries.

Growth for digital advertising (in India) is projected to be the fastest at a CAGR of 18.6%, while television advertising is expected to grow at a CAGR of 11.1% between 2017 and 2021. Digital advertising will reach $1.7 billion by 2021, up from the estimated $740 million in 2016, according to the report.

Among traditional media, radio will see the fastest growth at 14.7% CAGR and will be a $826 million industry, up from estimated $416 million in 2016.

“Unlike the global economy, which will see a shrinking contribution from the entertainment and media sector over the outlook period, in India the sector’s growth rate will outpace the overall GDP growth rate. Being a relatively under-developed market in terms of per capita spend on entertainment and media, will allow India to grow at 10.57% over the next five years,” said Frank D’Souza, partner & leader, entertainment & media, PwC India.

The Indian film industry is expected to experience strong growth to become the third largest cinema market, after the US and China by 2021, growing at a CAGR of 10.4%. Unlike the global trend, the Indian newspaper industry is expected to record a positive growth rate of 1.1% CAGR between 2017 and 2021.

However, the report added that the online advertising market in India remains immature due to a lack of internet access across the country. “While several over-the-top (OTT) platforms have launched in India and both smartphone usage and online video viewing are growing, lack of broadband infrastructure continues to limit the market. Fixed broadband penetration remains low at just 6.9% in 2016. The high cost of wired Internet access (and computers and laptops) means that it will remain unaffordable for the vast majority of Indian households,” the report said.

“In Indian context, internet remains an expensive proposition especially when you have to pay for separately for the content and connectivity. We have a cheaper option of television. It’s true that digital is growing fast but it’s over a very small base. Being the least digitised market, India will allow the traditional media to grow without disruption by digital,” said D’Souza.

India is the second-largest subscription TV market in the Asia Pacific region in terms of the number of subscription TV households, which reached 154.3 million in 2016. This number is expected to expand at a 1.6% CAGR to reach 166.9 million subscription TV households by 2021. “As the economy grows, this presents strong opportunities for expansion in the TV market,” the report said.

Source: Newspaper article in Livemint

Real Estate Dilemma

Some regular readers of the Diary have been asking on the social media as to why I have stopped writing on real estate.

Actually, I haven't, it's just when it comes to real estate, I have had nothing new to say for a while. But today's piece is about real estate. Not that this has something very new to say, but the story that I came across was interesting enough to be discussed in detail.

First and foremost, I would like to thank Pune based Ashish Deshpande, Director, Paradigm Wealth Managers, for bringing this to my notice. So here is the story.

On the insistence of a friend, Deshpande went to check out a new real estate development in Wadala in Mumbai.

His friend could only afford the one bed room hall kitchen (BHK) that was on offer. And how much did it cost? Rs 1.8 crore. Deshpande got chatting to the builder's sales guy and asked him, how many end users were actually buying the one BHK apartments. The sales guy, not surprisingly, answered 90 percent. I mean, what else could he have said. He is expected to sell apartments not philosophise about them.

Of course, like a good sales guy, he was lying. Deshpande then asked the sales manager to imagine the profile of the guy who would in a position to pay Rs 1.8 crore to buy an apartment to live in it. Let's do a little maths to get into a little more detail here.

A bank or a housing finance company would finance up to 80 percent of the value of the apartment. This means a home loan of Rs 1.44 crore (80 percent of Rs 1.8 crore). Let's say the individual who wants to buy this apartment goes to the State Bank of India. He takes on a twenty-year home loan at 9.25 percent per year.

How much does the EMI on this amount to? Rs 1,31,885 per month. How much does a person need to earn per month for the bank or the housing finance company, to give him the required home loan? Assuming around 40 percent of the salary goes towards the EMI, the monthly salary would have to be around Rs 3.3 lakh. This would mean an annual pay of around Rs 40 lakh.A bank or a housing finance company would finance up to 80 percent of the value of the apartment.

How many people actually earn that kind of money? Further, the individual would also have to arrange for a downpayment of Rs 36 lakh (Rs 1.8 crore - Rs 1.44 crore). How many people have such a saving? Also, would you expect someone earning as much as Rs 40 lakh per year to live in a one BHK apartment? Would take a very desperate person to do that.

Deshpande offered this logic to the sales manager (not in as much detail). Then the manager let the cat out of the bag and said that most of the people purchasing one BHKs were buying it as a second home. People buy second homes typically to put it on rent to make a regular income, avail of the huge tax deduction that is available or to simply invest money and stay put. Or they simply have some money lying around and they don't know what to do with it.

Rental yields (annual rent divided by the market price of the apartment) are currently around two percent. So why would anyone in their right mind buy a home to put it on rent? Even after tax returns on fixed deposits, for those in the 30 percent tax bracket work out to around five percent.

When it comes to saving tax, the strategy perhaps makes some sense. In case of a second home loan (and third and fourth and so on) the entire interest paid on a home loan is tax-deductible as long as a notional rent is added to the income.

But what complicates matters in this case is that the delivery of the apartment is not scheduled up until 2020. That essentially increases the risk given that there are a whole host of under construction properties that haven't been delivered over the last few years.

Also, the apartment comes with the condition that it cannot be sold before possession is granted. So this basically means that it is a five-year investment and can be sold only by around 2021. So what is a reasonable rate of return for an investor to expect in this case? Deshpande works with a simple rate of return (and not compounded) of eight percent per year. This would mean an absolute rate of return of 40 percent over a period of five-year.

This basically means that five years later the apartment should be worth at least Rs 2.5 crore (actually Rs 2.52 crore to be very precise). If we include stamp duty and other charges (which also need to be recovered) the apartment should fetch at least Rs 2.75 crore in 2021.

A simple rate of return of eight percent per year might just work in this case because the buyer is also getting a huge deduction for the interest that he pays on the home loan. But what if someone is looking at least at a compounded rate of return of 10 percent per year? Then the price of the apartment has to be around Rs 2.9 crore in 2021. And this is without taking the stamp duty into account.

Now, imagine one BHK apartments selling for Rs 3 crore in 2021? These are the numbers we are looking at. What if there are no buyers? As Deshpande puts it: "in the absence of an end user your investment becomes a fixed deposit fetching 2% return annually with principal not in sight or at least at big risk."

So where does that leave us? It brings us back to the Greater Fool Theory of Real Estate. Or the theory on the basis of which people are still betting on real estate. The expectation is that at the end of the holding period of five years (in this specific case) one will always be able to find a greater fool who is willing to buy real estate at an even higher price. In more general cases, the expectation is to find a greater fool who is willing to buy.

If that is how you like to invest, then all I can say is best of luck. Or maybe you have a lot of black money lying around. And there is still no place better than real estate to launder it.

Speciality Chemical Industry

Specialty chemicals, which comprise low volume, high value chemicals with specific applications, constitute a significant part of the Indian chemical industry.

The shift of manufacturing to the East and India’s export competitiveness is expected to strengthen India’s position as a manufacturing hub for specialty chemicals. A glimpse of India’s emergence as a major export hub is already seen in segments such as agrochemicals and colorants, in which a significant part of India’s production is exported.

A more tangible metric to distinguish between specialty and bulk chemicals is the EBITDA margin of the business. Specialty chemicals, by virtue of being high value, specialised products command higher margins than most bulk products.

Specialty chemicals can be sub-divided based on end-user industries. End-use driven segments (agrochemicals, personal care ingredients, polymer additives, water chemicals, textile chemicals and construction chemicals) and application-driven segments (surfactants, flavours and fragrances and dyes and pigments) constitute over 80% of the specialty chemicals universe.

The nine segments that we have covered cumulatively constitute a market of USD 18.8 bn in India and are expected to grow at 12% p.a. to reach USD 33.2 bn by 2019. The largest segments are agrochemicals and dyes and pigments; these are expected to grow at 11–12% p.a. Water treatment and construction chemicals, are expected to be the fastest growing segments with expected growth rate of 15% p.a. over 2014-19.

Specialty chemicals finding applications across consumer (eg. personal care chemicals), industrial (eg. water chemicals) and infrastructure (eg. construction chemicals) segments are driven by the overall growth of the Indian economy. Agrochemical growth has a strong linkage to the growth of the rural economy.

In certain segments (such as agrochemicals, dyes and pigments, flavours and fragrances), a significant proportion of production in India is exported.

Key trends in the Market

Regulatory and environmental considerations : Developed markets are tightening their import regulations due to environmental concerns and also to protect domestic manufacturers.

Shift of production to Asia : Many MNCs are focusing on Asia, particularly India and China, as their manufacturing hubs as a result of tighter environmental norms in the west. This has been particularly evident in relatively standardized products with low differentiation, such as textile chemicals and dyes and pigments, wherein IP protection hasn’t been a significant threat.

Recently, tightened pollution control norms in China have led to multiple plant shutdowns in the country in chemicals and other manufacturing segments. As a result of this, Indian chemical manufacturers have gained from production shift to India, especially visible in segments such as Dyes and Pigments.

Inbound activity :

• Gaining market access / increase in market share : Eg. Evonik’s acquisition of Monarch Catalysts (May, 2015)

• Creating a manufacturing base : Cost efficiencies and shifting base from the west due to more stringent environmental regulations

• Sourcing and strengthening of supply base (intermediates/ ingredients) : Eg. Mane’s acquisition of Kancor Ingredients(Nov, 2014)

• Acquiring brands and distribution network : Eg. Nihon Nohyaku ‘s acquisition of Hyderabad Chemicals (Nov, 2014)

• Enhancing product portfolio : Eg. Clariant’s acquisition of Plastichemix (Apr, 2014)

Outbound activity :

• Technology access : Eg. Sudarshan’s acquisition of Ekcart (Dec, 2011)

• Market access : Eg. UPL’s acquisition of DVA Agro do Brazil (Jul, 2011)

• Enhance product portfolio : Eg. Indofil’s acquisition of Dow’s dithane business (Mar, 2012) ; Dorf Ketal’s acquisition of Exxon’s

lubricant additives business (Mar, 2007)

• Strengthen global market share : Eg. Dorf Ketal in organometallic titanates : DuPont, Johnson Matthey, etc. (Jan, 2010 and Aug,

2010 respectively); Kiri’s acquisition of Dystar (Dec, 2009)

Agrochemicals, Flavours and Fragrances (F&F) and Personal Care are the three most attractive sectors in our opinion. They are characterized by strong product differentiation / specialization and strong end industry growth. Amongst these, Agrochemicals and F&F have a large market and a number of scaled up investible assets. 

Taken from a report by Avendus

Healthcare In India

Source: IIMB Lectures

Investments In Frontier Markets

Investing in frontier markets can come with a higher degree of volatility than more established markets, but they offer exciting potential. Some of yesterday’s small, agrarian economies have transformed themselves into global powers today—China being the most impressive example. China represents the second-largest economy in the world today, depending on how you crunch the numbers, and it has been incredible to see the changes taking place there in my lifetime. It gets me thinking about economies that were viewed as largely untouchable or risky for investors and travellers even just a few years ago, but that today are being discussed as interesting potential destinations for both.

Here are some examples from recent history of countries that were shunned or out of favour in the international community at large, but have undergone big transformations. This includes some emerging and frontier markets that are currently of great interest to us, and countries we are not yet investing in, but that are opening up to investors.

China

In 1950, trade between the United States and China was roughly US$200 million annually when China became subject to an embargo that lasted 21 years, ending in 1971.1 Today, trade between China and the United States adds up to more than US$500 billion, making China the United States’ second-largest trading partner.2 China has undergone a huge growth spurt over the past three decades and has transformed its economy. For emerging markets investors, China is a destination that certainly can’t be ignored and remains an engine of growth for the world. Even if market watchers have to get used to a “new normal” of slightly slower gross domestic product (GDP) growth than in past years, we think the 7.4% growth rate China reported in 2014,3 and the target of around 7% in 2015 Chinese premier Li Keqiang gave at the National People’s Congress in early March still looks impressive, given the size of China’s economy, and is not something that concerns us.

Japan

An adversary to the West in World War II, Japan is an example of a market that moved rapidly from frontier to emerging to developed market status and is now considered one of the strongest allies of both the United States and Europe. Japan’s rise to economic strength has been well-documented as one of the biggest post-WWII achievements and its high-quality, high-tech goods have permeated nearly every corner of the globe. Since its boom times of the 1980s, Japan’s economy might be stagnating, but it still holds plenty of sway in the world’s economy. Its government has been working to increase consumption and jump-start growth through an ambitious, three-pronged fiscal and monetary approach. In our view, the quantitative easing regime the Bank of Japan began in 2013 that continues today should help support global liquidity and trickle down to emerging markets in the region.

South Africa

Apartheid, a system of legalized discrimination dating back to the 1950s, cast a shadow on South Africa in the eyes of the international community for many years. In addition to United Nations sanctions, the US Congress passed the Comprehensive Anti-Apartheid Act in 1986, resulting in the withdrawal of many large multinational companies from South Africa. The end of apartheid in South Africa in 1994 opened the door again to wider investment in the country, but since then, its economy has been struggling to reach its full potential for a variety of reasons.

South African stocks have started 2015 on a solid note, aided by the recent drop in oil prices. In particular, retail businesses (particularly clothing and food) seem to be benefiting from the potential boost to domestic consumption from lower fuel prices. While South Africa has been struggling with an electricity crisis that could stunt GDP growth this year, we continue to believe that attractive long-term investment opportunities exist across a range of South African markets and sectors.

With the government’s focus on redistribution of wealth and extensive social grants, companies that provide goods and services to consumers at the low end of the income scale have benefited tremendously and, in our view, should continue to do so. Also, many South African-based companies that generate a substantial portion of their income from operations and investments in other markets have benefited from a weakening of the South African rand relative to the US dollar and other major currencies. The real estate sector has been stable with price growth in recent years, fueled by demand that substantially outstrips supply, especially at the entry level. In this regard, the financial sector plays a key role, with banks taking a fairly conservative approach to both asset-backed and non-asset backed lending activities. Moreover, a number of South African companies are investing on the rest of the African continent across a variety of industries, including infrastructure, retail, financial services and telecommunication.

Here are some examples of frontier markets that were out of favor, but are transforming and opening up to wider foreign investment. These are just a few of the markets in which we are investing, or watching for potential future opportunities.

Vietnam

Since the end of what’s known as “the Vietnam War” in the United States and “the American War” in Vietnam, the country has seen some huge changes. Vietnam’s rise hasn’t been as powerful or fast as Japan’s post-WWII experience but a construction boom has been underway. In 2010, Vietnam got its first skyscraper, the striking Bitexco Financial Tower, which stands as a beacon in Ho Chi Minh City. An even taller building is currently under construction in the city, expected to rise to about 350 meters and contain a luxury hotel, apartments, shopping and what is said to be Southeast Asia’s highest restaurant and bar. Franklin Templeton has an office in Ho Chi Minh City, and it’s been exciting to visit the city and see the changes taking place there and around the country.

The middle class has been growing in Vietnam and people have also been trading in bicycles for motorcycles, scooters and automobiles. To help alleviate the traffic on busy city streets, Vietnam’s first-ever subway system has been under construction with the help of foreign investment from Japan, France and China.

The chart below shows how Vietnam’s people have been eager to have access to new technology, with growth in mobile phone subscription rates topping even India and the United States during 2002–2012.

While it is clear there has been progress, Vietnam’s transformation has been slower than we’d like. The war was so traumatic and the people remain a bit sensitive about foreign dominance, which has hindered the acceptance of foreign investment. The Vietnamese seem to be gradually overcoming these reservations because of the positive developments they see to the north in China, and we have recently seen more movement in allowing greater foreign investment. Vietnam’s stock market is not very liquid, and it is considered a frontier market; but Vietnam has had a fast-growing economy, and we have found good companies there, including some that are state-owned.

Myanmar

I had the pleasure of visiting Myanmar earlier this year, and it’s a perfect example of what we view as “the next frontier” of untapped markets in which we aren’t yet investing but are closely watching. It’s truly a wonderful place that has seen a big change in policy and global perceptions. My most recent visit included a trip to Mandalay, an incredible city with its royal palace still intact. The city remains in a time warp but 640 kilometers to the south, the country’s largest city and former capital, Yangon has skyscrapers and development. Growth has also been robust, with GDP growth of more than 8% in 2013 and 2014 and expected at a similar pace in 2015.4  However, Myanmar’s capital markets have a long way to go before we can consider investing there in a meaningful way. Elections coming up in November could have a big impact on acceptance by the United States and other countries that have had embargoes and other constraints to doing business there. If Myanmar can successfully hold an election that’s considered to be fair, we might see more constraints loosened.

During our visit, my team and I met with officials who are planning a stock exchange, but it will take some time to develop the necessary financial system infrastructure. Implementation of foreign investment will take time; in order to invest, we need custodial banks and so on.

To do business effectively in a country, we believe it’s important to understand the culture and the people, including traveling there and talking with ordinary citizens as well as government officials and business leaders. Myanmar is steeped in history and is deeply religious; gold-covered pagodas can be spotted in nearly every city, and in the countryside, you can sense the deeply embedded spirituality in the culture.

Cuba

Cuba is another country that we are not yet able to invest in, but are watching closely. There has been a lot of excitement recently about what appears to be a new chapter in Cuba-US relations, including the possible restoration of diplomatic ties between the countries and the end to decades of US sanctions. The US State Department has conveyed that the United States aims to lift restrictions on travel, commerce and financial activities with Cuba. However, with a Republican-controlled Congress and a strong anti-Castro Cuban diaspora still holding some influence in the United States, it seems unlikely that rapid progress will be made unless there are more signs of democratic reforms in Cuba. Nevertheless, it seems obvious there will be some opportunities for airlines to increase flights to the island following relaxed travel rules—and we’ve already heard that message from a few US carriers eager to service or expand existing charter services to Cuba. US banks could also benefit since US tourists visiting the island will be allowed to use credit and debit cards issued by their banks, and US bank accounts of Cuban citizens living on the island will be unlocked. Remittances from the United States to Cuba are being raised from a maximum of US$2,000 to US$8,000 annually, but unless the 1962 embargo instituted by US President John F. Kennedy is lifted, foreign investment from the United States into Cuba will remain severely restricted.

In my view, the impact on US firms of the new relationship with Cuba will likely be limited, at least in the short to medium term, but the gains for non-US firms could be substantial. I think Cuba’s ability to access the US market could make investing in export-oriented Cuban enterprises more attractive. If the embargo were to be lifted, then Cuban companies that escaped to the United States after the revolution could return and relocate there. The Castro government’s tight grip on the economy remains an additional barrier to wider investment, but there are some signs it could loosen, and food could be the first item of trade to be liberalized in Cuba. A US Agriculture Commission for Cuba including about 30 US companies and food-related groups headed by an executive of a US food giant has been lobbying the US Congress to lift the trade embargo with Cuba and ease trade sanctions. Despite the obstacles, we think the long-term opportunities for potential investment in Cuba look enormous.

Frontier Markets General Outlook

These are just a few frontier markets we are watching—there are many more we are also excited about. Looking long term, we believe the structural reasons behind frontier investing in general remain generally solid, including good potential growth rates in many frontier economies, strong domestic and capital markets growth, technology transfer, demographic advantages and generally low sovereign and private indebtedness. Of the 10 countries estimated by the International Monetary Fund to have achieved the fastest economic growth between 2003 and 2013, eight were frontier markets, with China and India being the other two (see chart below). The underlying growth profile can be particularly attractive in frontier markets, as they tend to be more exposed to their domestic economies—many of which are developing rapidly—as opposed to the global economy, which is growing at a slower pace. Furthermore, technology leapfrogging and partnerships between emerging markets that are able to supply capital and technology (such as China), and frontier markets with low labor cost structures, could be particularly potent sources of growth.

In the current environment, a number of countries are undergoing positive developments while headwinds remain for others. Headlines of conflict and tension in some emerging and frontier markets continue to affect overall investor sentiment. At the same time, the improving macro environment and lower political risk have benefited individual economies (Sri Lanka and Bangladesh being two examples). In recent days, major world powers have been discussing a United Nations Security Council resolution to lift sanctions against Iran. Meanwhile, planned economic reforms and a new International Monetary Fund loan program could further promote Pakistan as an investment destination.

While we don’t know what the future will bring, this demonstrates to us how important active management—including on-the-ground research and a bottom-up stock selection process—is when it comes to investing in emerging and frontier markets.

Mark Mobius’s comments, opinions and analyses are personal views and are intended to be for informational purposes and general interest only and should not be construed as individual investment advice or a recommendation or solicitation to buy, sell or hold any security or to adopt any investment strategy. It does not constitute legal or tax advice. The information provided in this material is rendered as at publication date and may change without notice and it is not intended as a complete analysis of every material fact regarding any country, region market or investment.

Data from third party sources may have been used in the preparation of this material and Franklin Templeton Investments (“FTI”) has not independently verified, validated or audited such data. FTI accepts no liability whatsoever for any loss arising from use of this information and reliance upon the comments opinions and analyses in the material is at the sole discretion of the user. Products, services and information may not be available in all jurisdictions and are offered by FTI affiliates and/or their distributors as local laws and regulations permit. Please consult your own professional adviser for further information on availability of products and services in your jurisdiction.

What Are the Risks?

All investments involve risks, including possible loss of principal. Foreign securities involve special risks, including currency fluctuations and economic and political uncertainties. Investments in emerging markets, of which frontier markets are a subset, involve heightened risks related to the same factors, in addition to those associated with these markets’ smaller size, lesser liquidity and lack of established legal, political, business and social frameworks to support securities markets. Because these frameworks are typically even less developed in frontier markets, as well as various factors including the increased potential for extreme price volatility, illiquidity, trade barriers and exchange controls, the risks associated with emerging markets are magnified in frontier markets.


- Mark Mobius Report