Churn at the top

The travails of HUL, Infosys and Dr Reddy’s capture why large caps are getting poor discounting compared with their smaller peers

By Mohan Sule

The results season never stops to surprise and amuse. Titans numb investors with poor numbers even as dark horses stun with awe-inspiring performance. The period also marks a turning point for the equity market. Companies dissect past performance and lay the roadmap for the remaining year. Inevitably there is a feeling of change in the air as no two quarters are alike. It will be tempting to write off the June 2016 quarter as yet another showcase of the competently reliable and the notoriously unpredictable. This would be a mistake. For one, the period was the last phase of the impact of the rural distress. Second, Corporate India was operating near mid-point of a new government’s tenure, with enough time to absorb its past policies and assess future direction. Third, the global economy continued to be in a flux as never before: China’s slowdown looked inevitable, US recovery fragile and the financial markets uncertain about the fallout of the two-year of UK’s disengagement with the euro zone. Amid the turmoil stood India, displaying vulnerability about its export earnings and at the same time exhibiting confidence about its domestic economy. If the enabling environment was so full of concerns as well as excitement, could companies remain immune? The tough period of the last few years exposed fault lines. First, the era of crony capitalism is slowly but surely grinding to a halt. Auctions of natural resources, cleaning up of bank balance sheets and the commodity meltdown have knocked off the market cap of quite a few magnates.

Second, certain boom industries seem to have had their run or losing steam. Teflon-like sectors are increasingly being linked to global and local factors just like many other Old Economy cyclical industries, while some are facing the winner’s curse. As long as the US was undergoing a bull phase, the major worry of IT companies was the dent in income in the third quarter due to the longish Christmas break. The focus of the consumer disposable segment was coaxing buyers to upgrade to achieve better margins. If the 2008 mortgage meltdown burst the tech bubble, the two consecutive deficit monsoons of 2014 and 2015 pulled down the lifestyle sellers.  If a repressive regulatory regime was suffocating their well being in the licence raj era, intensifying competition is pinching formulations and intermediate producers. Capturing the essence of the headwinds are three Nifty constituents: HUL, Infosys and Dr Reddy’s Laboratories. They are still the flag bearers of their sectors, steadfastly sticking to their knitting and not foraying into unrelated businesses. Minority shareholders have been amply rewarded through capital appreciation and regular payouts. Yet their numbers for the June 2016 quarter have confirmed a trend noticeable since the last couple of years. They are ageing, are increasingly becoming indistinguishable from their peers and even ceding ground to new entrants.

Once a leader, HUL has become a follower, trying to ape entrepreneurs riding on the desire of Indians to go back to their roots in contrast to the yearning for Indian-made foreign goods during the pre-reforms era. Infosys is encountering growth fatigue. There is limit to geographical expansion if the world looks like a fiery red globe, mid-tier companies snap with low-pricing deals and the forex market turns into a foe. Dr Reddy’s formed one of the two pillars of the pharmaceutical industry with Ranbaxy Laboratories late last century. Ranbaxy promoters, perhaps sensing the shaping of the industry into a first-past-the-goal post during a limited window, sold out and a relatively newcomer, Sun Pharmaceuticals Industries, has assumed the pole position, with the pure domestic play turning attention to exports to stay in the race. Investors would have got better post-tax yield from one-year fixed deposits of public sector banks than from the troika. Facing pricing pressure, they are dispersing their band-with by chasing every growth avenue. The tech sector controls 20% of Nifty’s balance, with financial services and energy being the two other segments enjoying near parity. HUL has twice the weight of Asian Paints, the only other consumer disposable player. If ITC, slotted in an independent category, is included, the FMCG sector has the highest share in the benchmark. Financial services have turned volatile with even private banks bogged down with NPAs, ferrous and non-ferrous metals facing a slump in demand, telecom weighed down by capital expenditure, automobiles waiting for demand pick-up and power and capital goods limping, the large-cap index is being driven by cement, two-wheelers and refineries. No surprise, therefore, for the poor discounting compared with the mid- and small-cap compatriots having domain focus.