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Jio: Yet to see very big scalability in Reliance Jio and Retail over next 3-5 years: Emkay Investment

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Export-oriented businesses like pharma, CRAM and the specialty chemicals will have exceedingly good growth even in FY21. But in FY22 and FY23, we expect a lot of these businesses to have very nice EBITDA and bottom line growth, says Sachin Shah, Fund (Portfolio) manager, Emkay Investment Managers.

Some of the top stocks in your portfolio are from the pharma API space which is the hot favourite of the market right. Laurus, Divi’s are solid companies. What is your understanding of the earnings profile versus the valuation some of these names are now trading at?
As you must have already seen, we have a fairly decent allocation to the pharma sector and to be very frank and honest, have had these allocations for a while now. Each of these stocks have been in our portfolio for more than two to three years. In fact, Divi’s has been there for more than five years and even Laurus Labs and Suven Pharma have been with us for more than a couple of years now. We have been very constructive on each of these businesses basically as there are very unique opportunities with each of these businesses — be it contract research and manufacturing, CRAMs business, speciality chemicals and speciality API drugs.

The kind of scalability, opportunity that these businesses offer is humongous in the global markets. We have also seen that in the last two-three years barring the last six months. In the calendar year 2018-2019, the pharma sector was trading at very low valuations. Whereas the underlying business trends were going in a very positive direction and a lot of that seems to be now accelerating post Covid. Some of these businesses have actually done very well.

Not only that, the strategy of global majors de-risking from the Chinese manufacturing and looking at alternatives, particularly in the API space, in the contract research and manufacturing space, some of the Indian companies have already established themselves over the last few decades, at least in the last 10 years or so. They have demonstrated that they have the capabilities and the scalability to meet global demands. From that perspective, the Indian pharmaceutical industry has a huge opportunity and the last quarter results of some of these companies were very strong and the management commentary for each of these businesses is very constructive going ahead for at least next four to six quarters. That is where they have a very strong visibility.

But not only that, if you talk to these managements, they will tell you about the kind of opportunities that they see over the next three to five years. They have not even scratched their surface at this point in time. So we continue to remain very constructive on each of these names and that is why they have become top holdings in our portfolios because of the stock price performance in the last six months. In the last six months, particularly the post Covid environment, pharma sector has been the best performing sector for multiple reasons.

How are you reading the Reliance Retail opportunity? We all saw an unprecedented flurry of activity on the fundraising side in case of Reliance Jio. Now Reliance Retail has got its third cheque. How do you value the retail side of the business?
One of the top holdings in our PMS is Reliance Industries. One of the big reasons we owned this business was that they have been more than five years in the new generation businesses or probably longer. But now they are trying to reach a very different scale and to my mind, the way they are integrating these businesses both on the Jio side and on the retail side is that it is almost like a paradigm shift in the business.

A consumer spends a lot of time on digital and by offering retail services on a digital platform, it has been an amazing paradigm shift but still again, they have not yet scratched the surface. We are yet to see a very big scalability on both the businesses over the next three to five years.

How are you playing some of these smaller manufacturing companies like APL Apollo, Sundaram Fasteners — input providers to overall larger infrastructure/manufacturing OEM plays? How are these companies navigating the slowdown patch?
It is very interesting. The market is a great leveller and we have seen that in 2018 and 2019, the midcap and the smallcaps have lost a significant amount of their valuations to the extent that the gap between the largecaps and the smallcaps was so large that it was very difficult to believe. Now we are seeing that in this post Covid environment, the midcaps and the small caps have started doing much better than some of the largecap companies.

Obviously the valuations are catching up with the mean but in terms of business performances, there are two plays over there. One is a national play because as we know today, the rural part of India is actually doing much much better and so companies could adapt themselves where they could provide their products or services to the rural side of India or to the tier two, tier three cities in the country which have been able to bounce back much better. That is where companies like APL Apollo come into play.

There is another thing which is on the auto ancillary front. One of the names here are Sundaram Fasteners. It is an auto global play because again they can service large global players — be it in North America or European companies. Sundaram Fasteners has had nearly Rs 1,000-1,200-crore export turnover for the last three-four years. They have built good businesses with some of the global auto majors like General Motors, Cummins and Ford. They will have a huge opportunity as more businesses will start looking at alternatives to shift sourcing from China.

After the pandemic, what kind of earnings growth have you factored in both of your portfolios, going forward 1-2 years?
My sense is that FY21 is going to be a lot of mixed bag because in some of the businesses which are more domestic facing, the growth may not be there. In fact, there will be some kind of de-growth in FY21 but export-oriented businesses like the pharma space and the CRAM space and the specialty chemicals space will have exceedingly good growth even in FY21. But in FY22 and FY23, we expect a lot of these businesses to have very nice EBITDA and a bottom line growth. Even if the top line grows is at just about high single digit, the reason being that in most of these companies, the kind of the cost saving measures that they have enforced in these last six months are going to play out very strongly in the next financial year because as the top line comes in, the cost will not come back as fast and that will really percolate down to the bottom line in terms of the profit growth being much stronger than the top line growth.

My view is it will not be very unrealistic to expect between 15% and 25% growth.





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Why it might be good for China if foreign investors are wary

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Chinese economy updates

The writer is a finance professor at Peking University and a senior fellow at the Carnegie-Tsinghua Center for Global Policy

The chaos in Chinese stock markets last week was exacerbated by foreign investors selling Chinese shares, leaving Beijing’s regulators scrambling to regain their confidence while they tried to stabilise domestic markets. But if foreign funds become more cautious about investing in Chinese stocks, this may in fact be a good thing for China.

In the past two years, inflows into China have soared by more than $30bn a month. This is partly because of a $10bn-a-month increase in the country’s monthly trade surplus and a $20bn-a-month rise in financial inflows. The trend is expected to continue. Although Beijing has an excess of domestic savings, it has opened up its financial markets in recent years to unfettered foreign inflows. This is mainly to gain international prestige for those markets and to promote global use of the renminbi.

But there is a price for this prestige. As long as it refuses to reimpose capital controls — something that would undermine many years of gradual opening up — Beijing can only adjust to these inflows in three ways. Each brings its own cost that is magnified as foreign inflows increase.

One way is to allow rising foreign demand for the renminbi to push up its value. The problem, of course, is that this would undermine China’s export sector and would encourage further inflows, which would in turn push China’s huge trade surplus into deficit. If this happened, China would have to reduce the total amount of stuff it produces (and so reduce gross domestic product growth).

The second way is for China to intervene to stabilise the renminbi’s value. During the past four years China’s currency intervention has occurred not directly through the People’s Bank of China but indirectly through the state banks. They have accumulated more than $1tn of net foreign assets, mostly in the past two years.

Huge currency intervention, however, is incompatible with domestic monetary control because China must create the renminbi with which it purchases foreign currency. The consequence, as the PBoC has already warned several times this year, would be a too-rapid expansion of domestic credit and the worsening of domestic asset bubbles. 

Many readers will recognise that these are simply versions of the central bank trilemma: if China wants open capital markets, it must give up control either of the currency or of the domestic money supply. There is, however, a third way Beijing can react to these inflows, and that is by encouraging Chinese to invest more abroad, so that net inflows are reduced by higher outflows.

And this is exactly what the regulators have been trying to do. Since October of last year they have implemented a series of policies to encourage Chinese to invest more abroad, not just institutional investors and businesses but also households.

But even if these policies were successful (and so far they haven’t been), this would bring its own set of risks. In this case, foreign institutional investors bringing hot money into liquid Chinese securities are balanced by various Chinese entities investing abroad in a variety of assets for a range of purposes.

This would leave China with a classic developing-country problem: a mismatched international balance sheet. This raises the risk that foreign investors in China could suddenly exit at a time when Chinese investors are unwilling — or unable — to repatriate their foreign investments quickly enough. We’ve seen this many times before: a rickety financial system held together by the moral hazard of state support is forced to adjust to a surge in hot-money inflows, but cannot adjust quickly enough when these turn into outflows.

As long as Beijing wants to maintain open capital markets, it can only respond to inflows with some combination of the three: a disruptive appreciation in the currency, a too-rapid rise in domestic money and credit, or a risky international balance sheet. There are no other options.

That is why the current stock market turmoil may be a blessing in disguise. To the extent that it makes foreign investors more cautious about rushing into Chinese securities, it will reduce foreign hot-money inflows and so relieve pressure on the financial authorities to choose among these three bad options.

Until it substantially cleans up and transforms its financial system, in other words, China’s regulators should be more worried by too much foreign buying of its stocks and bonds than by too little.



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Square to acquire Afterpay for $29bn as ‘buy now, pay later’ booms

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Square Inc updates

Payments company Square has reached a deal to acquire Australian “buy now, pay later” provider Afterpay in a $29bn all-stock transaction that would be the largest takeover in Australian history.

Square, whose chief executive Jack Dorsey is also Twitter’s CEO, is offering Afterpay shareholders 0.375 shares of Square stock for every share they own — a 30 per cent premium based on the most recent closing prices for both companies.

Melbourne-based Afterpay allows retailers to offer customers the option of paying for products in four instalments without interest if the payments are made on time.

The deal’s size would exceed the record set by Unibail-Rodamco’s takeover of shopping centre group Westfield at an enterprise value of $24.7bn in 2017.

The transaction, which was announced in a joint statement from the companies on Monday, is expected to be completed in the first quarter of 2022.

Afterpay said its 16m users regard the service as a more responsible way to borrow than using a credit card. Merchants pay Afterpay a fixed fee, plus a percentage of each order.

The deal underscored the huge appetite for buy now, pay later providers, which have boomed during the coronavirus pandemic.

“Square and Afterpay have a shared purpose,” said Dorsey. “We built our business to make the financial system more fair, accessible, and inclusive, and Afterpay has built a trusted brand aligned with those principles.”

Adoption of buy now, pay later services had tripled by early this year compared with pre-pandemic volumes, according to data from Adobe Analytics, and were particularly popular with younger consumers.

Rivalling Afterpay is Sweden’s Klarna, which doubled its valuation in three months to $45.6bn, after receiving investment from SoftBank’s Vision Fund 2 in June. PayPal offers its own service, Pay in 4, while it was reported last month that Apple was looking to partner with Goldman Sachs to offer buy now, pay later facilities to Apple Pay users.

Steven Ng, a portfolio manager at Afterpay investor Ophir Asset Management, said the deal validated the buy, now pay later business model and could be the catalyst for mergers activity in the sector. “Given the tie-up with Square, it could kick off a round of consolidation with other payment providers where buy now, pay later becomes another payment method offered to their customers,” he said.

Over the past two years Afterpay has expanded rapidly in the US and Europe, which now account for more than three-quarters of its 16.3m active customers and a third of merchants on its platform. Afterpay said its services are used by more than 100,000 merchants across the US, Australia, Canada and New Zealand as well as in the UK, France, Italy and Spain, where it is known as Clearpay.

Square intends to offer the facility to its merchants and users of its Cash App, a fast money transfer service popular with small businesses and a competitor to PayPal’s Venmo.

“It’s an expensive purchase, but the buy now, pay later market is growing very rapidly and it makes a lot of sense for Square to have a solid stake in it,” said retail analyst Neil Saunders.

“For some, especially younger generations, buy now, pay later is a favoured form of credit. Afterpay has already had some success with its US expansion, but Square will be able to accelerate that by integrating it into its platforms and payment infrastructure — that’s probably one of the justifications for the relatively toppy price tag of the deal.”

Square handled $42.8bn in payments in the second quarter, with Cash App transactions making up about 10 per cent, according to figures released on Sunday. The company posted a $204m profit on revenues of $4.7bn.

Once the acquisition is completed, Afterpay shareholders will own about 18.5 per cent of Square, the companies said. The deal has been approved by both companies’ boards of directors but will also need to be backed by Afterpay shareholders.

As part of the deal, Square will establish a secondary listing on the Australian Securities Exchange to provide Afterpay shareholders with an option to receive Square shares listed on the New York Stock Exchange or the ASX. Square may elect to pay 1 per cent of the purchase price in cash.

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Biden puts workers ahead of consumers

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US economy updates

For the past 40 years in America, competition policy has revolved around the consumer. This is in part the legacy of legal scholar Robert Bork, whose 1978 book The Antitrust Paradox held that the major goal of antitrust policy should be to promote “business efficiency”, which from the 1980s onwards came to be measured in consumer prices. These were considered the fundamental measure of consumer wellbeing, which was in turn the centre of economic wellbeing.

But things are changing. A White House executive order on competition policy, signed last month, contains some 72 discreet measures designed to stamp out anti-competitive practices across nearly every part of the US economy. But it isn’t about low prices as much as it is about higher wages.

Like the Reagan-Thatcher revolution, which took power from unions and unleashed markets and corporations, Biden’s executive order may well be remembered as a major economic turning point — this time, away from neoliberalism with its focus on consumers, and towards workers as the primary interest group in the US economy.

In some ways, this matters more than the details of particular parts of the order. Many commentators have suggested that these measures, on their own, won’t achieve much. But executive orders aren’t necessarily about the details — they are about the direction of a government. And this one takes us completely away from the Bork era by focusing on the connection between market power and wages, which no president over the past century has acknowledged so explicitly.

“When there are only a few employers in town, workers have less opportunity to bargain for a higher wage,” Biden said in his announcement of the order. It noted that, in more than 75 per cent of US industries, a smaller number of large companies now control more business than they did 20 years ago.

His solutions include everything from cutting burdensome licensing requirements across half the private sector to banning and/or limiting non-compete agreements. Firms in many industries have used such agreements to hinder top employees from working for competitors, as well as to make it tougher for employees to share wage and benefit information with each other — something that Silicon Valley has done in nefarious ways.  

This gets to the heart of the American myth that employees and employers stand on an equal footing, a falsehood that is reflected in such Orwellian labour market terms as the “right to work”. In the US this refers not to any sort of workplace equality, but rather to the ability of certain states to prevent unions from representing all workers in a given company.

But beyond the explicitly labour-related measures, the president’s order also gets to the bigger connection between not just monopoly power and prices, but corporate concentration and the labour share.

As economist Jan Eeckhout lays out in his new book The Profit Paradox, rapid technological change since the 1980s has improved business efficiency and dramatically increased corporate profitability. But it has also led to an increase in market power that is detrimental for people in work.

As his research shows, firms in the 1980s made average profits that were a tenth of payroll costs. By the mid 2000s that ratio had jumped to 30 per cent and it went as high as 43 per cent in 2012. Meanwhile, “mark-ups” in profit margins due to market power have also risen dramatically (though it can be difficult to see this in parts of the digital economy that run not on dollars but on barter transactions of personal data).

While technology can ultimately lower prices and thus benefit everyone, this “only works well if markets are competitive. That is the profit paradox,” says Eeckhout. He argues that when firms have market power, they can keep out competitors that might offer better products and services. They can also pay workers less than they can afford to, since there are fewer and fewer employers doing the hiring.

The latter issue is called monopsony power, and it is something that the White House is paying particularly close attention to.

“What’s happening to workers with the rise in [corporate] concentration, and what that means in an era without as much union power, is something that I think we need to hear more about,” says Heather Boushey, a member of the president’s Council of Economic Advisors, who spoke to the Financial Times recently about how the White House sees the country’s economic challenges. 

The key challenge, according to the Biden administration, is that of shifting the balance of power between capital and labour. This accounts for the emerging ideas on how to tackle competition policy. There are many who regard the move away from consumer interests as the focus of antitrust policy as dangerously socialist — a reflection of the Marxian contention that demand shortages are inevitable when the power of labour falls.

But one might equally look at the approach as a return to the origins of modern capitalism. As Adam Smith observed two centuries ago, “Labour was the first price, the original purchase-money that was paid for all things. It was not by gold or by silver, but by labour, that all wealth of the world was originally purchased.” Reprioritising it is a good thing.

rana.foroohar@ft.com



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