Spoilt for choice

On offer are small caps with governance issues, mid caps taking debt to grow and large caps prone to missteps in using cash  

Investors are in an enviable position. There is an array of old economy sectors to explore: The dependable FMCG companies, private banks, NBFCs, automobile assemblers and pharmaceuticals producers. The fading of the disruption due to the recall of high-value notes and roll-out of the goods and services tax and the turning of the commodity cycle riding on the recovery of global economy have put into play oil and gas explorers, refiners, metal miners, capital goods and cement manufacturers, construction companies and providers of housing-related products. PSU banks are getting capital infusion and being empowered to drag defaulters to insolvency. The basket of emerging industries, too, is expanding, with the addition of small lenders, asset management companies and life and non-life insurers. Large-cap laggards are waiting to be picked. Mid and small caps beckon after many shed 30% and more flab. The market regulator has turned hawkish in monitoring stock movements. Policy makers are pump-priming the economy by a series of steps to provoke consumption, particularly in rural areas. GST has widened the tax base as the beauty of input tax credits motivates every tax payer to ensure that his supplier is compliant with the new regime. The arbitrage of price advantage to gain market share is disappearing.    

At the same time, investors today are a pitiable lot. Only about one-third of the more than 3,000- listed stocks trade regularly. Small caps celebrated for spotting niches are also susceptible to headwinds of macro-economic trend reversals, revision of policies and changes in market tastes. The other side of a booming economy that lifts airlines is surging prices of inputs.  The tight grip of the promoters that gives flexibility to change directions without much outside interference can be misused. An e-governance facilitator is now being probed for buying shares of a jeweller. Disclosures can be sketchy. A promising packer of fruit pulp went into a free fall on allegations of divergence of its plan on paper and on ground.  Corporate actions such as bonus shares and stock-splits can be deceptive as there is no outflow of cash. More information is available about mid caps. Their outlook is enticing but can become outdated quickly. An air-conditioner maker unexpectedly skidded in the June 2018 quarter after a `bad summer’. If the upside is survival bias in once-emerging sectors, the downside is sluggish growth. Presence of domestic and foreign institutional investors does offer comfort about their numbers and practices. The concern is the constant need for capital to achieve scale. A builder of airports, a sunrise opportunity, has a debt-to-equity ratio of 46. Ironically, the revenue visibility coincides with the economy heating up and the cost of raw material and money beginning to rise.

Large caps have the strength to withstand economic instability. Yet they are not immune to company-specific issues. Overseas buy of a domestic steel giant that seemed like a masterstroke turned a cash guzzler after the global meltdown. The boards of those that have dispersed ownership are prone to dither over resolving issues that can affect stock prices. In contrast are promoters who do not want to let go and make a mockery of price discovery. The price-to-earnings of a discount retailer with just 20% float is above 100. Opaque acquisitions, bumper compensation packages and accusations of conflict of interest have tarred brands in the private banking and technology services spaces. Usage of reserves becomes a lightning rod. Buybacks to shore up prices result in limiting liquidity and loss of interest among institutional investors. Unrelated diversifications are typical gestures to flank the core activity. The market is unsure if the primary business of tobacco should get more weight or the unevenly performing portfolio of hotels, foods and paper. A petrochemicals conglomerate has been re-rated not because of the cash that its refinery is producing but because of the promise of capital gains from telecom services. A personal-care MNC dependent on rural income is darting from indigenous solutions to frozen desserts to stay attractive. An infrastructure player’s subsidiaries providing financial services and software solutions are getting more interest. The shareholders of a quality private bank are figuring out the next move of the smart founder to dilute stake without causing destruction of wealth: offload shares, enhance the capital or undertake an expensive merger. Those who bought into a legacy LCV and M&HCV owner’s bet on top-of- the-line luxury passenger vehicles to capture China’s growth story are stumped as the local market is showing more potential. When it comes to side-stepping risks, investors do not seem to be spoilt for choice.        

-Mohan Sule