Business and Capital Market Environment

Business and Capital Market Environment

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So I've been slacking for a while now. My colleagues have been making these wonderful industry presentations. So some people were ostensibly missing me, I don't know, whether that was to make me feel good or to be regular in attendance here. Nevertheless. So today it's a slightly longish presentation in terms of number of slides. So I'll go through them quickly.

Most of them are pictorial, in terms of charts. And the second part will be some of the medium to longer term trends. We have spoken about them in the past as well, but we will just take a status update on that as to where we stand today and how things are going on that front. So let's dive into this.

Let's talk about equity markets. So the narrative currently is what happens now, are we going into a recession, not going into a recession? is it a new bear market or is it a bear market rally that we have seen after the fall, the recovery that we have seen? So just to give context, this is how NIFTY has done. So leaving aside the ups and downs, we are 43% higher than the pre-Covid levels in roughly two and a half years, which is more or less what equity markets do, in the medium to long term. So, it's not that it's something unusual. The fall was very, very steep. There was a recovery which overshot on the upside and we have given up some of the gains but broadly, if you are a longer term equity investor, and you have not been watching the stocking indices or stock prices or the NAVs on a daily basis or on a monthly basis, you would be wondering what the fuss is all about.

If you, if you just even out the journey it's more or less what is normal for equity markets. Again, so much of fuss is being made about interest rates - they've gone up and what will happen to valuations and what will happen to the economy and stuff like that. And these are not even very, very long term charts. I have personally seen Government bonds paying 14% p.a. semi-annual,

AAA Corporates borrowing money at 18% per annum and AAA NBFCs borrowing money at 21% per annum. So if we are at roughly 7.25, 7.30 yields on 10-year government bonds, this is something which we have seen within the last five years. So 2018 - 19 is when we have seen similar interest rates. So again, what is the fuss all about? Same thing for U.S. interest rates - The low interest rates that we saw a couple of years back, that was the anomaly rather than the current interest rates being an anomaly.

It's just that the Covid shock was so great or, the urge to avoid recession and to ease the pain for people was so much that interest rates were kept at very, very artificially low levels. And we are more or less in normal era. So when I say this to people, saying that interest rates are more or less okay, why is this fuss about equity markets are more or less okay. So the pushback that I get typically, is that but do you know what happened in the U.S. in 1980s, inflation went haywire, Volcker had to hike interest rates,

do you know what happened to India in mid-nineties? Inflation is the biggest worry. So that is the pushback. So rather than absolute levels of interest rates or absolute levels of equity indices, what people are most worried about today is this. So let's look at that in context. To my mind, there are only two things which are relevant here. When COVID hit

what did governments the world over do? They said, stay at home, Don't venture out unless it's absolutely critical. So Firefighters, Police, Medical professionals can go out, everyone else stay at home. No offices, no factories, no shops, nothing. So there was a tremendous supply shock, the after effects of that are still being felt the world over. That that was one part.

Second, people started screaming "how will we feed ourselves"? Governments said, no worries - Governments and Central Banks we will give fiscal support, we'll give monetary support - moratoriums interest rate cuts, free ration, free Gas cylinders, free stimulus checks in the West. So what happens when you cut out production and supply, and when you keep the demand intact? Initially, what happens is, inventories run down. After inventory is over, you have shortages, right? It's pure and simple that, I don't think there is any other way to read this.

Just look at this. So to transport one container from the east coast of China to west coast of U.S., it would cost roughly $1,400/- This is pre-Covid. That had gone up to as much as $12,000. Why? Because containerships were stuck at ports. If they could unload on the ports, there were no truck drivers to take the containers to the destination. There was shortage of container ships, there were shortage of containers and all sorts of bottlenecks were there.

This is one manifestation of bottlenecks. Crude oil, briefly in the Future's market in the U.S., they traded it negative prices. But, there was a big drop and then a big spike in the crude oil prices. Again, not just COVID, but the war which is there - Russia-Ukraine war.

Again, as a result of war where gas supplies have been curtailed to Europe, huge spike in energy prices. So what used to be somewhere between $4 to $12 in that range has suddenly gone up to $57 now - the LNG price. This is what has happened to coal. Since natural gas is not available at a reasonable price, people have started burning coal again and a country like Germany and all had shut down their Nuclear Plants; Gas is not coming from Russia. So what is to be done? And, what used to be less than 900 billion dollars prior to the global financial crisis went to 9 trillion dollars. So tenfold increase in U.S. Fed balance sheet. So when such a huge thing happens where you have huge supply shocks, you have huge amount of monetary stimulus, obviously you will have inflation.

So the question is not again, what led to inflation. If we just scratch below the surface, the answers are right there, staring us in the face. The question is what happens in the future.

Should we be worried about all these things and should. we be worried about our equity investments. I'll just go back to a couple of slides.

There are two interesting things in this graph. One of course is from 1,400 to 12,000. The other interesting part is the journey down for container shipping rates. Even in crude oil, what went up to beyond $120 is now mid 90s. Let's look at another shipping index.

This is for bulk commodities. Here the thing is even more dramatic - so huge shortage but we are back to almost median levels. There's hardly any shock over here in terms of shipping bulk commodities. Iron Ore, big crash from peak levels that we have seen. Copper, although somewhat elevated, but well down from the peak levels. Aluminum - again, slightly elevated, but, more or less where you were in 2019. One would prefer

as a consumer lower prices, but nowhere near the peaks that we have seen in the past. Wheat, which was the big worry because of the Russia - Ukraine war, again, significantly below the peak levels. People who track FMCG companies track this a lot.

Palm oil, which is a input for a lot of FMCG companies again, see the crash from the peak levels that we have seen. So the headlines that we keep seeing about inflation and interest rates and all that are yesterday's stories, they are not stories that we will read six months from now. That is my understanding. Again, even refining margins, which had gone up very, very dramatically are down now.

So I think this is something which is very, very interesting to keep in mind, when people talk about all kinds of shortages. So people talk about semiconductor shortage, right? The Taiwan economic minister, just put out a statement saying semiconductor volume growth year over year for Taiwan is 40%. They've just put out this data two, three days back.

So Taleb says that I've seen gluts, which sometimes may not be followed by shortages, but I've never seen any shortage, which is not followed by a glut. What we are seeing currently is the impact of huge supply chain shocks. Some of them have already corrected. Some of them are in the process of being corrected. Some of them may take maybe six months, 12 months to correct. In any case once sufficient enough time goes by where your year on year comparisons start looking back at a higher base.

Because of the base effect, the inflation rate automatically comes down. So hypothetically, let us say crude oil remains at a hundred dollars. Now when crude oil goes up from 80 to 120, that time there's a big inflation shock. But after sufficient passage of time, if crude oil is at 100 dollars, comparison becomes $120.

Then automatically the inflation rate optically starts looking lower. So I am not in the camp that thinks that we are going to see runaway inflation and double digit interest rates and stuff like that - the interest rate peaks will come sooner than we expect, maybe it has already come in a lot of economies. So, long story short, I don't think there's anything exceptional about the equity markets, despite all the hype and hoopla that we see in the financial media and on TV. Valuations are maybe slightly elevated but, neither in bubble territory, nor in extremely, undervalued territory; you have to be selective about what you buy. Interest rates are more or less normal.

Prices of various things are more or less normal. Some shortages are there, which are at somewhat elevated levels, but almost everything is coming off from the peak levels that we saw in terms of prices and the bottlenecks are easing out. So that's, as far as the markets go. So that ends one portion of the presentation. I don't want to spend too much time on it.

Jeff Bezos has his favorite saying - so he says, people keep asking me about what are the things that are going to change in retailing in the coming decade? He says, that's the wrong question to ask. I don't focus too much on what are the things that are going to change. My focus is on things that are not going to change. So in retailing, people will never say your prices are too low, I wish your prices were higher.

That is not going to change. Consumers will always want lower prices. He says, customers will never say that your shipping times are too fast. I wish the delivery would come slower. Customer customers will always want quicker delivery.

They will always want a wider variety of choice. They will never say, oh, there are too many options on your website. I only wish there were a fewer items available. So he says, these are things which are not going to change. So the second part of the presentation, we are going to talk about things which are longer term in nature. So I don't think as equity investors, we should focus too much about inflation, interest rates, commodity prices, and things like that.

We are better off focusing on things that will work over next 10 years, 15 years, 20 years. We will talk about two of such things which we have already covered in the past - we'll take something of a status update on those trends. The first big chatter that has been going around is the decline in prices of tech stocks. So, decline in NASDAQ, and decline in Alphabet, Amazon, Microsoft, Netflix, Facebook, all these kind of companies. So is that really the case? Let's look at this.

So while seemingly the prices have crashed from year to year and there's a small rebound, but pre-Covid, this was the level. In dollar terms, the index is 37% higher index NASDAQ. So again, like everything else, there was a big crash downwards, rebound was overdone, and some of the excess gains are being given up. I don't think there is anything which is exceptional in the way the stock prices have moved for some of these profitable technology companies.

Clearly, the environment is not of one of free money where we are in zero or negative interest rates or where free money is available from venture capitalists and things like that. So the non-profitable Tech is going through its own cleanup exercise, but otherwise, some of these profitable companies, they've seen drawdowns as much as 70, 80, 90% in their history. And, as long as the underlying business is more or less okay, I don't think we should focus too much on the ups and downs that are happening in these stock prices. Net-net, leave aside the stock prices, if we look at the core business, is there anyone in this room who believes that the future is linear TV where you sit in front of the television set, you press the button on the remote and you wait for the channel to telecast something at a particular time and you'll watch that serial only at that time. Is anyone in this room who believes

that is the future unlikely, right? People want to watch what they want, when they want. They will watch it on a device of their choice, whether it's a cell phone, whether it's a tablet or a large screen TV, they either want to binge watch or they want to watch part episode and catch up later. So streaming is definitely winning over linear TV and linear radio. Digital, what was only on in terms of search ads has gone to large screen TV, even for brand building. So if, you guys are watching YouTube these days, and you don't have the premium plan, just look at the number of irritating FMCG ads that you see. Lever is a big advertiser on something like a YouTube these days.

So I think the addressable ads are the way forward. And again, the younger generation, let's say someone of my daughter's age, a 18-year old, you can't reach that person by advertising on Zee TV, for example. You have to reach such people either on Instagram or on YouTube. So that is the future. So again, cloud computing is winning over the on-premise servers.

E-commerce gained very rapid share in the COVID period is giving back some of the gains because obviously in COVID, hundred percent share went to e-commerce when physical stores were shut. When stores open, the some volume will be taken back by the physical stores, but the longer term trend of shift from physical stores to online, that continues. So I don't think fundamentally anything is different as compared to what we were earlier.

That brings us to the, Energy Transition piece which again is a multi-decade thing. And by some estimates, it is going to require a hundred trillion investment worldwide for this shift to happen. This shift is from fossil fuel energy to renewables, and from internal combustion engine cars to new energy vehicles. So this transition is a hundred trillion dollar transition, which will play out over the coming decade or two. So we have spoken about this in the past. Let's us take a look at where we stand and how are we in that trajectory.

So again, none of this is very, very new. So we have seen the Reva electric car on the road for more than 10, 15 years. the solar calculators were there when I was in school, windmills have been around for a hundred years.

What is interesting is that the pace of change has accelerated over the years. And again, we have referred to Tony Seba and his work on in this space - and it affects a wide variety of companies which are listed in India. So, if you look at the companies which were listed in Sensex in 1980, and you look at the Sensex composition today, you'll find a very, very different set of companies. So while those companies may not have gone away, but they are nowhere as close as important as they were in back in the day. So at that time, you had Gwalior and Century and those kind of companies which are not very, very important companies today in terms of the large cap indices. So something similar may play out over the next 10 or 20 years where some of the big companies either make the transition and continue to remain successful, or they get replaced by some of the newer companies.

What has changed over the last so many years is, what used to cost $76 in terms of the panels to convert solar energy into electricity, that fell to somewhere around 30 cents in 2015, and today it's around 26 cents as per the latest prices. The battery prices have been coming down. So it's because of the economics that the time is opportune for the transition. Not that any of these technologies are very, very new. They've been around for a really long time. This also has a big impact on geopolitics.

So, so far despite having a good demographic situation in India, where we have a young population, educated people, despite people working reasonably hard, we have been energy deficient and, we have to spend billions of dollars in terms of importing crude oil and petroleum products and other energy forms to India. A decade or two out, that changes. So if we are able to shift transportation to electricity and reduce our import bill, then it has a big impact. And all the resource-rich countries right now, which have created these scarcities and wars, where currently the energy prices are very, very high, those people are in fact, accelerating the transition towards newer forms of energy. Just for context today, if you have a mid-sized Sedan in Mumbai, and if you get your tank filled, it would cost roughly around 4,000 - 5,000 rupees to get a full tank of fuel. Electricity prices Let's say, if we assume three to four rupees per kilowatt hour per unit, the biggest Tesla cars have a 75 kilowatt hour battery. Even assuming

four rupees a unit, you can fill up your car effectively for 300 rupees. So that is the extent of difference in terms of running cost that is there in terms of the fuel cost. Now this is not happening, tomorrow or day after. Obviously there is going to be a transition period and obviously capital costs on electric cars are currently much higher than petrol cars so you really have to work out the economics and charging infrastructure has to be solved, but we are seeing the results on the road. So we are seeing in our own city so many electric buses, we are seeing so many Tata EVs running on the road, some of the Chinese brands like MG Hector and all on the roads.

So it's not a question of if - it's a question of when will this happen. And, if you are optimist, you may say it may happen in five, seven years, eight years. If you are pessimistic, you may say it'll take 15 years, 20 years, but this will happen. So earlier the choice was between having low cost electricity and, having dirty air versus having high cost electricity and having clean air.

Now that dilemma is no longer there. So given that the current tenders which are coming in, the electricity plus storage sometimes is very, very comparable to fossil fuel prices. So the last tender or one of the recent tenders that was there was at 3 rupees and 10 paise per unit. And, eventually we'll have a time where solar electricity is cheaper than fossil fuel electricity. What this is however creating is given that some of the renewable sources are intermittent, it is creating big intra- day price differences.

So solar obviously is available only when the sun is shining and not at night. So in the summer months you had this kind of price difference. In June of this year, at night, it would be 12 rupees, a unit and, morning 9:00 a.m. it would be less than three rupees a unit. So, this is the challenge because so far we have not been able to solve the storage problem at scale. With monsoon coming in,

this problem got resolved for a bit. Now again, of late we are seeing some signs of again, supply bottlenecks after this some of the bans which came in on some states from participating on the exchange. What will happen in the coming few years is, as solar becomes more and more prevalent, during daytime there will be over-generation.

And at night, there will be huge ramp-up needed. This we have seen in California where, this is the data from the California's electricity board effectively - SEB equivalent. So similar thing will play out in country after country, the world over till the time we are able to solve the storage equation Again, storage At small scale we are familiar with lead acid batteries, with lithium ion batteries in our cell phones and stuff like that.

But at scale, we haven't figured out how to do that. Various things are being worked out. So one is, to my mind, a very interesting thing where, in hydroelectricity, in hydroelectric dams, you pump up the water from a lower level to a higher level during daytime when electricity is plenty.

And you run down the water through the turbine at night when you need the electricity. So obviously there is some loss in efficiency and, things like that but still it's a effective way of storing electricity. There are various other technologies which are being tried out, but currently the most prevalent one, where people are betting on is, grid scale lithium ion batteries where Australia is trying out some of these and, some places in the U.S are working on this. In India as well we are working on this. So, these are new stories which have come out. Again, Ladak,

where lot of work is going on on the solar side, we are working on solar plus storage over there. Green hydrogen is again something on which a lot of work is happening. So in the past, we have not spoken so much about green hydrogen. I got interested in this space when I read coverage of Reliance's AGM, where they spoke a lot about green hydrogen. So tried to figure out what this is. So solar electricity is fine as far as residential power goes, commercial power goes, transportation goes, or industrial electricity goes. But a steel plant right now would

burn so much of coal - coking coal to convert iron ore into steel. Or a cement plant will use coal. So how do you use renewable sources for industrial purposes? That has been a area where we seemingly did not have solutions, but apparently hydrogen can be used for industrial purposes. And, if that hydrogen is generated by clean energy, then it is called green hydrogen. Currently, most of the hydrogen is gray hydrogen, which is created using fossil fuels. But hopefully sometime in the future, we will also have capacity to create green hydrogen.

So that is something interesting. So not just on the Lithium ion battery front, but even some of the hydrogen fuel cell electric vehicles, there is some work going on. So lithium batteries work well for cars and stuff like that, but trucks have to transport very, very heavy loads and battery vehicles may not be the best solution for trucks. So hydrogen fuel cell is a viable solution for that. And industrial thing also works on hydrogen. So this is again a interesting space to watch out.

And, some of the bigger corporates in India are, have announced plans to work on this - Reliance most notably. In the COVID year we saw some setback in terms of roll-out of solar panels. But that is picking up now again and hopefully we'll be crossing the earlier peaks, in the current year.

So COVID was a setback, but I think we should be good and we should be back on track pretty soon. As it is, electricity in India is a mess because of subsidies and power theft and a lack of proper billing and stuff like that. But with the coming of renewable energy, there will be more chaos in the coming days because the grid will have to accommodate these intermittent sources of power; producers sometimes may get offtake sometimes may not get offtake. And finally, do you allow people to set up rooftop solar at industrial scale? Do you allow net metering and things like that? So, a lot of questions are unanswered currently.

So when you listen Tony Seba, everything seems Utopian and everything will go like clockwork and transition will happen but, reality is a bit messy when you actually come down to the ground and try and figure out what things are happening. So there is this interesting report from IEA you can access that on their website, india energy outlook 2021. So this is the composition of primary energy that we use. If we see large scale adoption of EVs, then this oil demand that is there could get converted to electricity. And that actually will put pressure on coal in the interim; not longer term - longer term solar and renewals will come in, but near term, we haven't invested in electricity generation traditionally.

And we have had a big push on solar, but we haven't really worked out how to manage that intra-day gaps. So, a below three rupee unit price during daytime and 12 rupees at night, we really haven't worked out how to handle that intermittent nature of renewable energy. So, as and when electrification happens on transportation, then a lot of this demand could go away and that could actually put pressure on the electricity sector in India per se. So right now, solar installations are ramping up, storage is severely lagging behind, EVs are here at very, very decent price points and, for a country like India, more than what is happening to Tesla, what is happening to a company like BYD is more relevant because those are at the entry level and mid-level cars and a lot of developments are happening in that space. And, ironically in the short to medium term because of the huge underinvestment in traditional energy sources, that is a place where you could see severe shortages happening when all this demand comes about.

So, just a couple of months back, I was in Gujarat and although this is not the actual picture, but something similar was happening over there where this huge truck was transporting one fin of a windmill, to take it somewhere and install it. So a lot of people think that all this renewable energy will manifest itself suddenly and we'll have a clean and green world; but to create so much battery storage, to create so much solar capacity, to create so much wind capacity, a lot of fossil fuel will need to be burned to bring that about. So in the interim actually, it'll create so much demand for trucking and for transporting all of these things at the right place and the right time. Yeah.

So, this is a place where I think apart from the internet and others, things that we have been talking about in the coming 10 - 15 years, I think a lot of change will be coming in this space and some people will create enormous value and some companies may no longer remain dominant as they are today. Thank you. I'll take questions, whatever they are.

2022-08-30 18:46

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