Leveraging Regulatory Cycle

We often discuss and debate on opportunities and threats because of market cycle ( which is influenced by supply and demand ) , but we rarely discuss opportunities and risk created by regulatory cycles …

In this thread my objective is to discuss different sectoral opportunities that were generated in past or being generated in current times because of regulatory cycles

To get most of this thread my humble request is we should not to clutter this thread with stock level discussions . Kindly limit discussion to Regulatory cycle and sector influenced - how and why

What is Regulatory cycle ??

To promote or discourage growth of a sector often Government initiates " reversible" policy actions - which can have both temporary and permanent impact on sectoral value chain . These can lead to structural growth/ decline stories in some sectors which could last for several years or at worst can provide arbitrage opportunities in short term for stock investors .

The key word here is reversible and hence it leads to cycle of asset and resource re-allocation across sectors … which is supposed to be back to normal once policy action is reversed .

How does this regulatory cycle manifest ??

It oftens starts with Government perception of ( illustrative list not exhaustive one )

  1. Sectoral problems of uncompetitiveness for long duration thereby impacting investments - We can see in recent times how Government has initiated multiple regulatory intervention in sectors like Agriculture, Real estate , Commodities like steel & pipes etc

  2. Potential for large scale employment - Classic case is how IT services was promoted in 1990s through slew of government induced incentives

  3. Sovereign level strategic risk : Sectors like Food , Steel , Telecom , Electricity , Finance etc Government intervenes depending upon its view on strategic risk perceived - like who can own an asset , how long he can own it and under what terms Government can take back etc

  4. Inflation Risk - If there is long term inflationary risk Government can encourage supply in specific sector and vice versa when there is inflationary risk - Government can create obstacles … Some sectors which have wide impact like Food , Pharma , Electricity , Oil , Telecom & Credit etc often are subjected multiple intervention

  5. Health & Environment Risk : Food, Pharma, Tobacco , Liquor , Auto , Chemicals etc often are incentivised or penalised based on Government perception of these risk

How this Regulatory Cycle gets kickstarted ??

  1. Scarce Resource allocation or prioritization - Resources means Land , Water , Energy etc - Changes in this policy can make or break a sector or industry and hence on needs to be extra careful in placing huge bets or paying huge premium for such sectors.

Lets understand this from examples -

  • Coal allocation by Coal India in recent times - Government decided 100% electrification is its target and allocates more coal to Power generators on priority - Then it is +ve for Power generators but negative for say Aluminum company which requires coal for its plant - This effect can be temporary but gives investors a good opportunity to leverage from market inefficiencies with one to two years investment horizon

  • Land allocation for IT parks in 1990s @ concessional rates - This was huge structural advantage given to IT services to set up large infrastructure and hence be relevant for global clients . So while IT services gained and scale up - Manufacturing sector suffered as they not only had to buy land at regular prices , plus with lot of licensing delays meant their cost to build up went up … At the same time since IT services saved on rentals and land they could offer better terms to engineers thereby leading to exodus of talent available for Manufacturing sector …

-> Gas prioritisation : Read this https://www.business-standard.com/article/economy-policy/cgd-firms-to-get-priority-in-gas-allocation-rejig-114070700543_1.html . In 2014 with passage of such a policy it changed cost structure of many fertiliser & power generating firms leading them to near bankruptcy whereas it improved economics for CGD companies . We could see growth in share prices of IGL and listing of Mahanagar gas and large scale agressive bidding for CGD licences across multiple cities . Now what if Government changes prioritisation in line with Farm distress or need for electrification . So one needs to be careful in paying high multiples for stocks with regulatory impact

  1. RBI Policies on Priority Sectors : This has huge impact on cost of capital asset heavy companies which require capex for growth . Being of priority sectors

To be contd

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