Mr Rahul Bajaj, chairman of the Bajaj Group and a former
parliamentarian has a penchant for not holding back his punches. At a public forum (and in the presence of a
Union Minister) at the World Economic Forum in Nov 2012, he not only accused the
government of policy paralysis and weak governance but is also reported to have
said: ""We decided many years ago, decades ago, that we will not do
business where we have to deal with the government. We don't manufacture, we
don't buy things for the government... We are in motorcycles, the financial
services... We do not want to have anything to do with their bidding process".
He seems to have said openly what many in the Indian business
say in private.
As per basic Economic theory, in a free
market economic system, resources are allocated through the spending
decisions of consumers combined with the supply decisions of producers. When
demand is high, the potential profit from supplying to a market rises, leading
to an expansion in supply to meet the rising demand and vice versa. Adam Smith conceived the existence of an
invisible hand of the market as a metaphor to describe this self-regulating
behavior of the marketplace.
But very often, it is almost as if the
invisible hand of the market forces is made to talk to the Government’s visible hand.
Government as the saver-spoiler
Per its mandate, the Government can always intervene whenever it
feels that it needs to protect the Consumer or Businesses from the free Market
forces.
QE, stimulus measures, TARP, trade restrictions, pricing
restrictions (e.g. Indian Pharma), Forex interventions – there are several
forms in which the Governments world-wide force their hand. Much as we love to loathe the government interference, one has to
admit that the Government does have a fiduciary responsibility to intervene
when things go out of hand. Whether they
are effective or not (or more devastating than useful) is another matter
altogether.
But one aspect of the discussion is whether Government
intervention is a nice to have on a more generic basis…you know.. like on a
Macro basis. And entirely another
whether we as investors should have anything to do with companies that have negative
exposure to Governmental intervention.
One specific company that I have in mind for the
discussion is Indraprastha Gas Limited (IGL).
Before the Regulatory storm hit IGL, it was considered in the value investing circles as a Buffett stock. It had a ready market: a monopoly over supply of CNG (later also PNG) in Delhi and much of NCR, combined with the statutory requirement that all public transport buses, auto, taxis etc. need to ply on CNG (which as a fuel, has a pricing advantage over Petrol). And it had pricing power: it had demonstrated an ability to pass on any increase in its Gas procurement cost to the Consumer (unlike the downstream oil companies who, being under Government control, could not raise prices of fuel without first checking with the Government). Good growth, great returns, good management, negative working capital… the works.
Then, in April 2012, PNGRB, the Government appointed body for Petroleum and Natural gas, gave an order that shook up not only IGL, but the entire City Gas Distribution (CGD) industry. PNGRB mandated that IGL had to cut its tariff by ~ 63% (on a retrospective basis from 2008!) and return the excess collected by it back to the consumers. In effect, this would have meant a serious challenge to the networth of the company while eroding its operating margin completely. This is what happened to the IGL stock.
An
over 50% fall in a matter of hours.
IGL duly
took the case to the Delhi High Court and won it in June 2012, upon which, the
PNGRB took this up with the Supreme Court of India (SC), which is where the
case presently is. The next date for
hearing is listed for April 4th 2013. Issue 1.
To
complicate matters further, there has been a simmering dispute inter-se the
Government, PNGRB and gas distribution companies on something called a marketing
margin which is a part of the final cost charged by the Gas distribution
companies (including GAIL, RIL as well as the CGDs). The Government and PNGRB desired transparency
and uniformity in the charge and the latter needed to have the freedom to
control it depending on their requirements and circumstances. There is no final word on this. Yet. So
this is the 2nd Damocles sword hanging over IGL’s head, so to speak.
Mind
you that the marketing margin is a fairly critical element because technically,
even if the Supreme Court case was to go against IGL, they could hike the
marketing margin to safeguard their margins.
And as
if these 2 issues weren’t enough, another recent complication is the APM gas
allocation. The price of natural gas
produced by National Oil Companies, namely, Oil & Natural Gas Corporation
Ltd. (ONGC) and OIL India Ltd. (OIL), is sold at Administered Price Mechanism
(APM) price – which is lower than market price – for the purpose of usage in
high priority industries such as power, fertilizer, CGD etc. This price was last revised in 2010 when it
was doubled from $1.9 per
million metric British thermal unit (mmbtu) to $4.2mmbtu.
Unfortunately,
the low prices of gas under APM have had the effect of discouraging these companies from
making investment in further exploration. Helped by this realization and doubtlessly
some energetic lobbying by Reliance Industries (they also want a revision), there
are moves afoot to double the price of APM gas to $8-8.5mmbtu sometime this
calendar year. It has been
reported that the Ministry of Petroleum and Natural Gas has forwarded the note
to the Cabinet citing the Rangarajan Committee’s suggestions along similar
lines.
No doubt that
such an action’s larger implications on matters such as inflation – that too in
an election year, will be discussed seriously at the Cabinet. But the Government seems to be eager to show
that it can take bold policy actions. And
this matter has assumed an urgency since this was obliquely mentioned by the FM
in the recent Budget speech.
So there you
go.. An example where Governmental
action – if and when it happens on the APM pricing – is clearly good for
the long term benefit of having prices that are market driven and not
artificially created (the new rate of $8mmbtu is closer to market price than
$4.2). And certainly there are winners,
viz., the Gas producers who were till recently at the wrong end of the
stick. But there are losers too (all
users of APM gas, viz., gas based power, fertilizer and CGD companies – and by
extension, all consumers of the final product, be it power, fertilizer or CNG/
PNG – as most certainly, the producers will need to pass on the cost).
Back to the
implications of all of these items on IGL.
So we have
discussed 3 uncertainties on the company’s future: a) the dispute with PNGRB
(currently at SC) b) the dispute of the marketing margin and c) pricing of the
APM gas. All having the imprint of the
Government hand on them.
As regards the
SC case, I understand that there is a lot of rumor mongering in the market
regarding the final verdict – most of which suggests that the verdict will
happen soon and IGL will win hands down.
How that has emerged, I have no idea since the company officials
themselves privately and otherwise show no such bravado. And they are in touch with the legal
proceedings.
As regards the
other 2 items of uncertainty, there is no saying when the Government is going
to move (or not) on them. Suffice it is to say that there are larger forces at
play on such decision making.
However, negative or positive outcomes of each of these issues could move the stock substantially and hence I submit that these are not low risk/ high uncertainty outcomes where the profit could be large. On the other hand, these are high risk/ high uncertainty outcomes where one needs to be very careful.
I would thus ascribe probabilities on each of these outcomes and a value to the stock on each such consequence. Here is what I have done:
You can work on
more situations and ascribe different probabilities or values to it. But either way, my decision would be to look
for an exit to the company as evidently the probabilistic workings (above)
based on currently available facts, don’t show a material upside to the current
price.
Sad end to a
favorite holding but with too many uncertainties – each with large negative
implications, I would rather leave something on the table for someone else who
is willing to assume that risk.
Once again Mr.
Bajaj – I have to agree with you. I
don’t like talking to the Government hand either..
