Crop Insurance and Commodity Trading- Farmer will See the Sky-Finally..................................................................... Stocks Covered: MCX India, Tube Investments, Sundaram Finance, Max India.

Farmers don’t see the sky…they just WATCH it…with hope and most of times with despair. The sky as we know (and enjoy) isn’t known to the farmers. They see a different sky…for them it is from where their lives flow…water. We may be enjoying the falling sky…but for our poor farmers every fall is not a water fall. We may have placed satellites beyond the sky but our farmer is watching the sky for thousands of years…for them nothing has changed…satellites broadcasts entertainment shows for us…but sky is always a broadcaster of horror for farmers.

India is a farmland…we have vast length and breadth of farmland with 60% of our people are sky based. The average size of farm land holding is around 3 acre. 85% of the Indian framers are cultivating the 70% of farm lands which are below two hectares each, more than 60% of the farm produces come from the small farms only. So we can’t think about economy of scale…and with low productivity from smaller farmlands; no doubt our farmers are vulnerable and terrified by the sky. But if India wants to touch the growth sky then we need to free our farmers from sky. I have no doubt that next leg of Indian growth will come from rural India. Rural India is neglected for so long…we think that high growth in agriculture in past decades should have brought prosperity all over the villages; but it is not as farmers aren’t able to earn the biggest pie which they should but the same has gone to the middlemen.

Poor small farmers are still poor…they still know moneylenders not banks. Farmers can’t store their produce due to lack of warehousing…they urgently need cheap electricity (Not free and subsidized; we need to produce cheap but profitable electricity), they need roads to carry their produce (although their small produce makes it costly to transport it to point of demand), they need timely advise for cropping. The list of things which can remove the variability from the farmers’ income is still long; but the factors bringing this variability are even bigger and most of the times beyond the reach of farmers and policy makers like floods, hailstorm, and fire etc. So apart from policy paralysis induced infrastructure deficiency they face the agony of the nature helplessly. 

That’s why when somebody says that power sector is all but gone in India; i find the statement and logic powerless. There is huge unmet demand for power in villages...one bulb lighting at home is not electricity. We are yet to see the real growth of the Indian power sector. The current lull will force out the inefficient ones and only mighty will remain (I see Tata power as the next biggest after NTPC, a great long term play).

Certainty of stable long term income/cash flow is the biggest decisive factor  whether you are planning for domestic consumption or taking any investment decision…the moment you have any surety of long term stable inflows…you can take the decisions as you can plan with assured cash flows. Hence I feel, insurance of farm income will make the Indian growth story comprehensive. Right now there is high distortion in the spread of income. In one season, they earn bumper but in the very next season they are ruined to the bottom either by Nature or by market forces like slump in the prices.

So now we need to see which factors can bring the stability in the farm income. Apart from policy based decisions I am seeing some niche solutions which can play very important role in the development of rural India. Let’s see these:

Crop Insurance: India, due to its huge reliance on agriculture, should have a strong crop insurance structure but only for complex structure of Indian agriculture. Crop insurance is one thing which is not in the radar of many but it is some serious business opportunity. Crop Insurance is a part of general insurance which I feel is even better opportunity. Indian equity markets will take some time to understand the valuation of Life and General insurance companies when more IPO’s of insurance companies will come. But I still feel insurance is the business which is not easily understood by many because it is indeed very complex.

Understanding Insurance Business

Profit and loss account and balance sheet of an Insurance company is very different from any other company we understand. Let’s have a short glimpse; Insurance companies have two main sources of revenue first is Underwriting profit which is the net excess of premiums received over claims paid. Like in a term plan, Life insurance companies collect the insurance premiums from policyholders (in case of endowment plans, a part of premium is towards Life insurance which is treated as income and the balance is kept for investment purposes on behalf of the policyholder) and in the event of death it pays the sum insured as claims…so any net premium excess is underwriting profit. Indian Life insurance companies are now making underwriting profits but General insurance companies which deal in Motor, marine, health and Fire insurance etc. are not making any underwriting profits at all. General insurance companies in India are selling policies at low premiums to get more business due to fierce competition and future growth strategy. First private General insurers started the battle with four public sector giants having 100% market share. During this fight which started in 2000, the four state-owned companies - New India Assurance, National Insurance, United India Insurance and Oriental Insurance - have seen their combined market share fall to 55 per cent from 100 per cent. This fight is keeping the general insurance premium at low levels. So right now every general insurer (Private/Public) except Bajaj Allianz is incurring underwriting losses in India.

So how these General insurance companies are making profits? With the answer, we move to the second source of revenue for the Insurance companies and this is-Investment Income. Insurance companies receive premiums and pay the claims against premiums received. But there is time Gap between these two events…they are not paying claims immediately…there is always a time gap between premium period and claim period during which Insurance companies can use this float to earn investment income from the premium amount. Float is the money that doesn’t belong to Insurance companies but which they temporarily hold. So Insurance companies invest this float money into so many investment options like Bonds etc. and earn investment income. Indian general Insurance companies are profitable only due to this investment income.

But things will change when these insurers will target underwriting profits after the consolidation in the Indian insurance sector. IRDA has also directed for compulsory listing of general insurance companies operating for more than 8 years and 10 years for Life insurance companies. The insurance regulator has said that all companies meeting the stipulation on minimum years of existence for listing should initiate steps to get listed within a period of three years from the date of issue of directions under these guidelines.

After listing there will be pressure for underwriting profits. Also amid falling interest rates, I think insurance companies would need to look beyond investment income. But general insurance is a great business opportunity in India as penetration levels are still very low in India. General Insurance business, once it achieves a scale, is a highly profitable business with very strong brand loyalty. Return ratios are very high in general insurance which is more like a necessity than a choice like Life insurance where people are literally chased for taking up the life insurance. Motor, Health insurance are among the necessities of the life these days. We can’t take a chance to avoid these.

So I think we’ll be seeing some of the most profitable business opportunities when the IPO’s of these general insurance companies will come. But as we have always done; it is way better to pick these before many are aware of this. So I am continuously buying the stocks like Tube Investments of India (Cholamandalam MS general insurance is the Subsidiary), Sundaram Finance (Royal Sundaram General Insurance), Max India Ltd (Max Bupa Health Insurance).

Crop Insurance is another big opportunity

History of unsuccessful attempts for Crop Insurance is very long in India. Unsuccessful is due to the complexities involved in the crop insurance and strained financial position of states/center Govt to fund the crop insurance. Unlike other forms of Insurance, crop insurance claims happen in heaps as it is not that floods will destroy only one or two crops in a Village. Entire village will be affected but again the impact of floods will be different on every single standing crop which necessitates measuring the loss of every individual farmer. However small land holdings of farmers in India make the administration of this task very costly which only raises the cost of insurance.

Also, as I have mentioned earlier, poor infrastructure in Indian Villages for Farming like poor irrigation, low use of Pesticides, Inadequate storage facilities, low quality seeds etc. further aggravate the situation as these factors increase the vulnerability of the crop loss to the farmer even in case of a low level calamity. All these factors impact the calculation of Actuarial Insurance premium which becomes very high due to these constraints and risks. So we can see how things are intertwined…bad infrastructure is also impacting the decision making at other fronts. Farmers can’t bear this high premium which sometimes is 20-25% of the sum Insured….even 10-15% is a high sum. If a farmer wants to insure his Kharif crop for Rs. 40000 per acre then at a normal premium rate of 10-15%, he has to shell out Rs. 4000-5000 which is very high for a poor farmer. Even Government can’t subsidize it fully. So all this resulted in payment of Low Insurance premium both by farmer and Government Subsidy which only resulted in low Sum Insured. In most cases, sum insured barely covers the cost of cultivation.

New Crop Insurance scheme can be a game changer

But current Government in Jan-2016 introduced a New Crop Insurance scheme; Pradhan Mantri fasal Beema Yojna (PMFBY). Here, premiums are fixed for farmers at 2% of the sum Insured in case of Kharif crop, 1.5% in case of Rabi and 5% in case of Horticulture crops. Sum Insured is kept at high levels on the basis of average per acre yields in last seven years (excluding calamity years) of a village. These average yields are then multiplied with Minimum Support prices to get the figure of sum insured. Actuarial insurance premiums are calculated for each village. After the contribution from farmers as mentioned above, the balance premium is shared equally by state and central governments. Hence there is no cap on the sum insured because there is no cap on the premium payment. All depends now upon the will of state and center government.

Due to high cost of Insurance earlier, only 20% of farmland is covered under insurance (Out of 200 Million hectare only 40 Million is covered). Although under coverage is not the only problem; inadequacy of the coverage is even bigger problem. But PMFBY is trying to sort out the both issues. Here as sum insured is kept high at actual loss of crop value hence there is no upper limit on the premium subsidy to be provided by state and central governments. But it is still far better than shelling out compensations after the calamity…waiver of loans etc.

One insurance company will be selected for one state on the basis of lowest premium quoted. That company will execute the crop insurance in the state. It can reinsure the crop insurance provided if it feels that risk is getting higher for its capability.

Technology is the key for crop Insurance success

The real test in Crop Insurance is how fast and accurate insurance claims will be processed as during earlier avatars claims took 3-4 years for settlement which becomes a joke on poor farmers. So here, supporting infrastructure and technology will be the key for successful implementation of the crop insurance. So farmers may see drones flying near their farms to capture the data for processing their claims when earlier assessment of loss was done by local Patwari by using Eye which was never credible and lead to corrupt practices.  Hence government needs to establish supporting infrastructure like weather stations in every block, use drones to assess damage and low earth orbit satellites to geo-tag plots to identify farmers.

With all this in place, if, say, a hailstorm flattens crop in a district in Madhya Pradesh, the satellites could pinpoint the plots and the geo-tags could identify the owner of the land. The weather stations would have already reported the hailstorm and drones would assess the damage more closely. The data is enough to make a quick assessment and the insurer can identify the farmer with the geo-tag and pay the claim directly into her Aadhar linked bank account. I think, drones and satellites (Remote sensing) can be easily implemented but weather station will require huge time and investments.

Actually, we’ll see more and more use of satellite technology in our day to day life in the near future as costs are coming down. Satellite internet is the biggest opportunity. Low earth orbit satellites will improve the internet speeds to compete with broadband. Reusable rockets will lower the costs of satellites even further. Broadband is a very costly affair especially in remote hilly areas where small users are scattered far away. It is very costly to dig lands and laying cables, mobile towers are a big nuisance and costly as they need continues power and high initial investments. So things are happening fast in the sky. That’s why the likes of Elon Musk of Tesla and Brenson of Virgin airlines have grand plans for Low earth orbit satellites. They are planning for around 4000 small satellites in the coming decade with around 600 by 2019 to provide speedy internet to remote parts of the earth where demand is strong and people can pay. Cable tv and broadband can’t stand on its feet in these remote areas. My main reason for buying Nelco was due to this coming of satellite internet. Tata communications is also going to be a big player in this arena.

General Insurance and Crop Insurance will see high growth in the near future

Indian General Insurance sector is Rs. 80000 crore story so far…out of which around 45% is Motor insurance and 25% is Health Insurance. So we can see with rural growth and demand for cars and bikes will result in high growth of Motor insurance although I feel in Motor insurance biggest growth will come from increase in the premium amounts. Health Insurance will see the high growth and will be the sector to watch. Indians are paying high health care costs out of their pockets which is a big negative and with more awareness people will realize the benefits of health insurance.

MAX India Ltd: My pick for Health Insurance is Max India ltd at 140…its main business right now is max healthcare which is growing fast but premium income of Max Bupa is good at 500 cr. Max Bupa now has strong brand positioning. Max Bupa and Max Healthcare will provide the high synergy to each other.

Crop insurance will be a big business within a year or so. General insurance which was on slow footing in last few years will see high growth in tandem with good economic growth. Actually the signs of growth are visible. In sep-16 alone, General insurance companies posted a growth of 88% yoy in gross direct premium.  In September, the general insurance industry saw gross premium income at Rs 15,087 crore against R 8,029 crore in September last year. Health insurance companies saw a 48.2% surge in their premium income in September. One of the factor of high growth in Sep-16 is crop insurance growth after good monsoon this season.

This year General insurance sector will touch Rs. 100000 crore premium collection figure as so far up to Sep-16 figure has already crossed 60000 cr. So we’ll see General insurance companies witnessing comprehensive high growth from this year. Market forces are sitting unaware of this big opportunity. Only when IPO’s will come then market will get a feeling of the business strength of General insurance industry. Hence I am regularly picking:

Tube Investments of India: Earlier advised at Rs. 400 last year but still way undervalued at CMP of Rs. 592. I have already posted a detailed blog post on Tube Click here. But i still feel it is a stunning stock to have; I am still buying it. So i am just revisiting it again:

 It is the owner of BSA cycle with 1500 Cr turnover and profits of around 70 Cr....its other businesses which are of substantial scale are tubes for various industries and metal formed products like door frames, chains etc....its clients includes the likes of Toyota, Tata etc. It is having around 70% share in Shanthi Gears. BSA cycle  has  a huge premium brand positioning in India....i see this business growing big in India. Its standalone business is around 4000 Cr with np around 250 Cr but will see it around 400 Cr  in near future due to recent capacity additions. So this was standalone.

But real gems are its holding of Cholamandalam finance which is a listed NBFC with market cap of 12000 Cr....Tube is having 46% of it. Another feather in the cap is its unlisted general insurance company Cholamandalam MS general insurance co.  Tube is having 60% share with balance with Japanese MS. Last Dec it sold of 14% for 900 Cr to MS which is lying with standalone arm. Cholamandlam MS General is having NP of around 170-200 Cr....but it is just the beginning. As explained earlier, all General Ins companies in India are incurring losses in underwriting business as they are in expansion mode and charging aggressively…they are earning NP from investment business only. But this will change soon and general insurance will grow big in India.

At CMP of Rs. 592 market value of just 11000 Cr.

Sundaram Finance: Pertains to top class TVS group. I have great regard for TVS group for their high class management skills. Just great people they are...TVS has never faced labour problems in their 100 year history. They keep their employee happy at any cost...Medical costs, including that of employees' family members, however high, are borne by the company. It also offers scholarships to their children. If an employee dies while in service, his dependents get not only his dues, but also the proceeds of a 'death fund' created for him.

Unions have best relations with TVS management which is seen seldom in India. TVS Management avoids top/senior level recruitment from outside...they try to give more chances to their employees.

Sundaram Finance has strong NBFC and Housing finance business apart from Royal Sundaram General insurance business. They are also having some other small but growing businesses like BPO and IT management business. Their general insurance has gross written premium of 1700 cr in 2016. Underwriting losses were Rs. 167 cr while investment income was Rs. 162 cr…so it is making losses but last year Net income was at 27 cr due to lower claims. In 2016, they paid higher claims due to Chennai floods. But there will be high growth in the business this year.

Sundaram is always proactive in making its books as clean as possible. It has done something remarkable in ensuring the quality of its loan assets. RBI in 2014 with a view to bring NBFCs at par with banks, had mandated that bad loan recognition happens at 150 days by end of March 2016, 120 days by end of March 2017 and 90 days by end of March 2018. This has impacted most NBFCs that have had to make additional provisioning for bad loans, in accordance with the new norms. But Sundaram Finance had already adopted a 120 day norm since 2012-13.

In 2015-16,the company has, in fact, moved to the 90 day norm, two years ahead of the regulatory norm. Despite this, Sundaram Finance’s gross NPAs are at 2 per cent of loans, when others such as Shriram Transport Finance (at 150 days from the March 2016 quarter) and Mahindra and Mahindra Financial Services (at 120 days) have higher gross NPAs of 6 per cent and 8 per cent respectively.

So these are the types of companies which we can hold for decades. At CMP of 1350 it is a good buy.

Commodity derivatives: Another big step in insuring Farm Income

MCX India Ltd: This is another innovative solution which can ensure the stability of the income of the farmers. Our farmers are ill equipped with the data to take the decision regarding which crop to sow. They mostly take their decision with rear mirror…they look at the prices of past season and crop accordingly which most of the times turns out to be a bad decision due to supply glut as every farmer is cropping the same crop which results in big price fall. We are seeing this all the time with prime victims are Tomato, Potato and Onions.

But if farmers can use agri commodity futures to hedge their produce that can solve their biggest worry. In fact, banks these days are asking and educating farmers while disbursing loans to use the hedging to safeguard their crops. Using commodity trading, a farmer can presell his produce at the commodity exchange thereby locking his sale price and saving his crop from any adverse price fall in the future. Futures and options can be used for hedging purpose. The only thing here is the awareness and education of the farmers and supporting policies of the government to promote commodity trading. Users of agri commodities like Pepsi (Potatoes for lays chips) also need these for locking their purchase price although they also resort to contract farming to mitigate the risk of high price variation. So this can be a win win situation for both.

There are quite a few real life cases in the past when farmer groups used commodity exchange to sell their produce and later price fall saved them big time. Commodity exchanges have also taken the task to educate farmers in commodity trading. In delivery based commodity trading, a high class certified warehousing is a must and we can recall many of our other picks like Snowman logistics, Balmer Lawrie, Concor, Redington, Gateway Distripark and Future enterprises (For Future supply chain) which are into high technology based warehousing and logistic business.

So I was looking for a commodity exchange for agri commodity trading. NCDEX is the leader in India with around 90% share but it isn't listed (but NSE, IDFC are the shareholders of NCDEX). However agri commodity trading is very low in India as compared to non-agri commodities like Gold, Oil and other metals where MCX is the leader at 90% share and it'll remain the leader due to NETWORKING effects. I think it is a great fit for the future; top management, monopoly, high growth in the future scale, big margins etc. are the key factors. No need to look at the high PE...it will change with the high growth in the future. MCX was blazing earlier but its turnover/profits were stalled due to imposition of CTT (Commodity transaction tax) by govt on Non Agri commodities in order to curb the speculation...although i think there can be some better solutions than just imposing tax every-time for every economic issue.

The things like CTT has resulted in high transaction costs for commodity trading in India forcing the likes of Hindalco/HZL to hedge their products in foreign commodity exchanges. If Government scraps the CTT in the near future then MCX will just blast.

Although at present, Agri commodity trading is a small part of turnover of MCX where NCDEX is the major force but MCX is taking steps for increasing its market share in Agri-commodity sphere so as NCDEX for Non-Agri commodities. Any positive outcome in this regard will be the biggest game changer for MCX. Also I hope NCDEX comes with the IPO.

I picked MCX recently (21^st Sep-16) around Rs. 1000 and it just started blasting after that. I made further buying at 1055 and 1160. It is now at Rs. 1300 after touching 1400 in just 10 days. The same was shared via email...but this time as more readers of this blog has subscribed to the email of this blog so i hope most of us are having it. But It is still a good buy and should be added at every fall.

(Views are personal and should not be taken as a recommendation for buying or selling a stock. Stock markets are inherently risky so kindly do your Due Diligence before investing. I am not a certified Sebi Analyst and holding the shares discussed in this Post)