Sunday, July 31, 2011

SP Tulsian: Selan Exploration.

Selan Exploration is into oil exploration. Though not a very big company, they produce about 3 lakh barrels of crude oil per year from their two operational blocks at Gujarat. Two more has already undergone 3i seismic studies and in my view, they should be operational in the next 6 to 8 months. Going forward, company should be able to ramp up production by about 50-100% in the next couple of years.

As for the financial position of the company, Selan Exploration is sitting on a cash balance of about Rs 100 crore. So they do not have to borrow any thing for this research and exploration survey activity. That translates into Rs 60 per share and if you see the financial performance for FY11, they posted an EPS of close to about Rs 18 with topline of about Rs 75 to 80 crore.

With the market cap of about Rs 550 crore and an enterprise value, if I knock out the cash held by the company, of about Rs 450 crore, and aided by the gradual upside we have been seeing in the crude prices, I think this can be a steady stock to hold in the portfolio. One can expect a price of about Rs 415 in the next 6 to 8 months time.


Fake Profit/Loss

High networth individuals who 'buy' loss/profit from friendly brokers to either suppress taxable income or convert black money into white, will find it difficult to do so, from August 1. This follows the new rules on modification of client codes (the client’s trading account number), effective from Monday. Under the new SEBI rule, brokers will be penalized 2% of the turnover value of the non-institutional trades done in the wrong account, if the turnover value of such trades exceeds 5% of the total monthly turnover value. For errors up to 5% of the total turnover value, the penalty is 1%.

Till now, if a broker had executed a trade in the wrong client’s account, he could rectify that error at the end of the day by shifting the shares. But the regulator and the stock exchanges soon found out that a quite a few brokerages were shifting trades from one account to the other to help clients either evade tax or launder unaccounted money.

There are many brokerages who thrive by charging 5-6% commission by providing fake profits/losses to their clients. It is not a bad deal for tax evaders who can still save 25% after paying the commission. For brokerages, this is a far more lucrative business than plain vanilla broking service, which earns just 0.01-0.25% per trade.

From Monday, if brokers change client codes after the trade is executed, it will cost them serious money. More importantly, the new rule will distort the economics of profit/loss shopping.

Here is how the freedom to change client codes was being abused by brokers.

Broker X is a proprietary trader who makes money through day trading—buying and selling shares for small spreads sometimes as low as 5-10 paise. Everyday the broker will punch in a few hundred buy trades and equal number of sell trades on his trading terminal. Suppose two clients, A and B, approach him with opposite requirements. Client A needs to show a loss of Rs 50,000 so that he can offset that much against the profit he has made during the year. Client B wants to show a profit of Rs 50,000 so that he can show that much unaccounted money as income from trading.

X shifts some buy transactions and some sell transactions into an account created for client A in such a way that it shows a trading loss of Rs 50,000. He will charge between Rs 2500-3000 as commission for this ‘loss’. Client A will hand over a cheque of Rs 50,000 to the broker, who will deduct the commission and return the remaining amount in cash. Similarly another set of transactions showing a profit of Rs 50,000 will be shifted into an account for client B. The broker will give a cheque of Rs 50,000 to B, who will then return the amount in cash, plus the commission.

To generate a profit/loss of Rs 50,000 on very low spreads, the broker will have to do trades worth at least a few lakh of rupees, and that too in highly liquid stocks. (Losses/profits in illiquid stocks quickly arouse the I-T department’s suspicion) Assume the turnover value of such trades is Rs 10 lakh. From Monday, if the broker shifts these trades into another account, he will have to shell out Rs 10,000 as penalty. This money will have to be recovered from the client, for whom now the cost of evading tax will be 25-26% and the cost of paying tax, 30%. If the total turnover value runs into crores, or even just Rs 1 crore, the whole operation becomes unviable. A penalty of Rs 1 lakh to buy a profit/loss of Rs 50,000 does not make any sense.

The new rule could benefit many individual investors, who were otherwise being shortchanged by unscrupulous relationship managers. Many high networth individuals who subscribe to portfolio management services of broking firms, give the power of attorney to brokers to trade in their accounts and generate profits. The relationship manager, in connivance with the branch head, can shift some of profitable trades into another account, and under-declare the profits to their clients.

Some brokers are worried that the SEBI has given too much discretionary powers to the stock exchanges in implementing this rule, and that the penalty is too stiff.

Here is what the SEBI circular on the new client code modification rules says:

“If a Stock Exchange wishes to allow trading members to modify client codes of non-institutional trades, it shall lay down strict objective criteria, with the approval of its Governing Board, for identification of genuine errors in client codes which may be modified, and disclose the same to market in advance.”

And the penalty will really hurt. Consider this: On Rs 1 lakh of turnover, a broking firm will earn around Rs 15-20 as commission if it is a derivative (futures and option) trade, and between Rs 200-250 if it is a cash market trade. But if the same trade is entered in the wrong account, the broker will have to shell out Rs 1000 as penalty. That is the equivalent of commission earned on Rs 50 lakh of F&O trade or Rs 4-5 lakh of cash market trade.

“If a broker is not careful, even a couple of mistakes could wipe out a significant portion of his income at a time when trading volumes are shrinking by the day,” said a broker, suggesting that the penalty should be linked to the commission earned on that trade.

Most errors relating to client codes happen on the derivative contracts expiry day, when there is a huge surge in volumes.

But the quantum of penalty suggests that the regulator is convinced that the brokers are changing client codes for the wrong reasons, and is determined to make the entire practice of tax evasion/money laundering unviable.

And the punishment does not stop at the monetary fine. Stock exchanges have to ensure that modification of client codes is covered in the internal audit of trading. That means serial offenders will be closely watched, even if they come up with ways to beat the system.

Thursday, July 28, 2011

How to think about the US debt battle?

If you don't believe me, ask Tim Geithner. He would say the same thing - if he could be sure that no Republican was listening.

That doesn't mean there's nothing to worry about, looking at the sorry saga unfolding in Washington this week. You just need to worry about the right things.

Both sides have an interest in talking up the risk of a formal default. Especially the treasury department - because it's Mr Geithner who will have to decide which bills to pay if it hits the debt limit without a deal with Congress.

But, as I pointed out a few weeks ago, the federal government will still have tax revenues flowing in after 2 August, even if Congress drops the ball - about $172bn (£105bn)-worth over the course of the month.

Mr Geithner only needs to use $29bn of that to meet the debt interest payment that is due on 15 August. Trust me, he will.

Maturing debt

Debt interest payments are only part of the story. To prevent a default, the federal government also needs to cover the principal on maturing treasury bills and long term government securities. The Bipartisan Policy centre estimates that $90bn will come up to maturity on 4 August, with another $90bn coming due on 11 August.

This, incidentally, is a vivid reminder of the different debt management practices of the UK and the US. Because the average maturity of US debt is so low, around $500bn of it comes up for maturity in August done.

IMF figures show that America has to refinance the equivalent of 18% of GDP this year due to maturing debt (and that number does not include short-term treasury bills.) The figure for the UK is less than 7% of GDP.

There's $30bn in treasury bills coming due on 4 August. The ratings agency Fitch has said that it would not necessarily place the US sovereign rating into default if those bills were not repaid in full on that date - as long as there was a strong expectation that the money, and accrued interest, would be paid before the next lot of treasury bills matured, on 11 August.

They would, however, downgrade that particular issue from AAA to B+ the moment the payment date was missed.

So, in theory, the issue of a downgrade could come up long before that big interest payment on 15 August. But there is nothing to prevent the treasury from doing what it would usually do when these notes mature: pay back the holders by issuing new ones.

'Damage perceptions'

Now, Secretary Geithner has told Congress he doesn't want to prioritise debt payments. He has also said the ratings agencies might consider the US to be in default if it failed to meet any of its obligations - not just the obligation to service its debt.

Finally, he suggested that there might be a shortage of buyers for new securities, if there were no debt ceiling in place.

This is what you would expect him to say. He wants a deal.

However, there is no obvious legal barrier to the US putting debt service before other obligations. And Fitch has explicitly rejected his second argument, saying that non-payment of suppliers or delays in paying benefits "would damage perceptions of US sovereign creditworthiness, but would not itself constitute an event of default from Fitch's sovereign rating perspective."

Put it another way: the ratings agencies don't really care whether grandma gets her social security cheque. They only care what happens to her treasury bonds.

Would investors sit out treasury auctions after 2 August 2 if no debt limit is agreed? Perhaps. But I wouldn't say it was the most likely outcome.

Additional collateral

So, even with no debt limit agreement well into August, a US sovereign default could be easily avoided and it almost certainly would be. It is also perfectly possible that the US could hang on to its AAA credit rating.

But, unlike a formal default, such a downgrade is clearly possible. Indeed, for Standard & Poor's, it's a near certainty, if Congress and the president fail to agree a major debt reduction package (with savings of $3 trillion or more over 10 years).

Would this be the end of the world? Well, it would be a brave new one. It could also be extremely messy - for example, if it raised questions about the treasury securities and US agency debt that are used as collateral in the $3 trillion US repo market, forcing financial institutions to post tens of billions of dollars in additional collateral.

But even then, there's room to doubt whether the implications would be so cataclysmic. If US debt were to go from AAA to AA, most analysts - for example, JP Morgan Chase - seem to think the extra haircuts would be inconvenient, but not much more than that.

Nervous markets

All this might sound hopelessly complacent. As we learned in the case of Lehmans, there's a lot we don't know about the intricate web of financial transactions that binds the global financial system together. The implications could be much worse than we think.

But here's a thought experiment for you. Assume that under existing rules for posting collateral (or, say, allocating institutional investments) the US moving from AAA to AA turns out to pose a major threat to US financial institutions. Which do you think is more likely to happen in those circumstances: the end of the world, or a change in the rules?

To be clear: a world in which the world's largest debtor does not have the top credit rating is not one anyone should welcome. No-one can be sure what the implications would be if the deepest "safe haven" market was no longer considered top notch. And clearly, this is a bad time to be launching experiments.

But precisely because this is such a nervous time for world markets, you have to ask where, exactly, all the buyers of US treasury bonds will actually go?

They can't all buy Swiss francs. For all the worries about global sovereign debt, this is still a sellers' market. That is why the yield on US 10-year debt is still barely 3%.

You might see that rate go up if the US politicians continue to make a mess of things, and the markets might be in for a few bumps. But, for better or worse, America is still in a class of its own. When it comes to the definition of safe government debt, it gets to re-write the rules.


Friday, July 15, 2011

GSPL awarded LOA for Pipelines.

The said three projects shall be required to be completed within a period of 36 months from the date of award of the letter of authorization to GSPL led Consortium.
Gujarat State Petronet Ltd (GSPL) has announced that GSPL led consortium has been awarded the Letters of Authorisation dated July 07, 2011 by Petroleum and Natural Gas Regulatory Board for developing three Cross Country Natural Gas Transmission Pipelines, namely: Mallavaram - Bhilwara (1585 Kms) pipeline, Mehsana - Bhatinda (1670 Kms) pipeline and Bhatinda-Jammu-Srinagar (740 Kms) pipeline.
Earlier GSPL (with 52% stake) in consortium with IOCL (26%), BPCL (11%) & HPCL (11%) had participated in the aforesaid three bids where in the bid submitted by the said consortium has emerged as the most favorable bid in all the three Pipeline Projects.

The route map of these three Natural Gas Transmission Pipelines cover the states like Andhra Pradesh, Madhya Pradesh, Maharashtra, Haryana, Punjab, Rajasthan and Jammu on its network for transmission of gas to various districts and area of these states of India. The total Investment in the Project shall he approx Rs. 125bn.

The said three projects shall be required to be completed within a period of 36 months from the date of award of the letter of authorization to GSPL led Consortium.


Thursday, July 7, 2011

Mahindra Satyam: Target Rs 109

IIFL Institutional Equities upgrades Mahindra Satyam to a ‘buy’ with a target of Rs 109. Mahindra Satyam is not 'back on track', but they believe it is very close to being so. Embargoes have been lifted at almost all the clients, though very few still exist. Operationally, its inefficient pyramid indicates large scope for margin expansion.