Echoes from the past

 

When 2020 appeared lonely as 1961, reimagining 1984, deviating from 1995, reliving 1999 and full of hope of 1969

28 December 2020

                                                          

Here comes the sun, do, dun, do, do/Here comes the sun, and I say/ It's all right

These lyrics by the iconic music band Beatles celebrated the imminent arrival of spring after months of a cold winter. As the sun sets on 2020, it does seem like 1969, when the resistance against rules broke free. After nine months of havoc wrought by a deadly pandemic, release from confinement looks possible in the New Year. History has a strange way to mutate over slices of periods. The Berlin Wall is a prominent example of physical demarcation to mark geographical boundaries. Countries transformed into clones of East Germany as they locked down their population in April, turning into ghettos after being flat, following the birth in 1995 of the World Trade Organization to demolish tariff barriers to ease inter-nation trade flows. If the restriction on free movement in 1961 was to insulate from the influences of fascism, the clampdown in the passing year was to contain the covid-19 outbreak. It took 27 years before the man-made edifice, executing social distancing in its worst form, was brought down. The battle to vanquish coronavirus has been shorter. The relief at the unification of people, who habituated the cyber world to bridge the separation in the real world, has been no less, with equity indices scaling new highs. The euphoric reception accorded to tech companies, which helped to remain connected, is an energetic replica of the 1999 dot-com boom.

The lapping of Facebook, Apple, Amazon, Netflix and Google’s parent Alphabet is reminiscent of the craze for Intel, Microsoft, Oracle and Cisco Systems two decades ago. The similarity between the IPOs of a room-rental aggregator and a cloud-storage provider now with internet properties then, such as Priceline.com, which bought airline tickets and sold them at prices passengers were willing to pay, extends not only to the 80%-100% pop over the offer price but also to their billion-dollar market cap on listing. If the tradition of romancing loss-making debutantes due to their outlook continues, so do rescue acts of failing institutions. Brining back from the brink two private lenders evoked memories of 2002, when the value of UTI’s underlying assets was lower than not only of its declared NAV but also of face value. The state-owned mutual fund-cum-financial institution was split into two entities to house rotten and performing assets. If social media seemed like a savior during the long spells of isolation, the dependence on these platforms thrust into reckoning the dangerous downsides. Their dominance and tracking of every move of the user seemed like reliving the chilling dystopian society conjured by George Orwell. The vivid portrait of life under surveillance in 1984 is coming alive 36 years later. Echoes of how data could be misused in the quest for information dominance reverberated in the recently concluded US president polls.  The scary control of a few American corporations on words capturing our thoughts, images of our best faces, snappy chats and snarky tweets have snowballed into a consensus that it is time for a break. The last time such a pervasive presence was chipped to size was, ironically, in 1984, when AT&T, a huge conglomerate that, once again in a bit of irony, controlled communications.

 

In India, another hulk was expanding its overarching influence, offering access to the internet, facilitating voice and data downloads, generating entertainment, enabling online- shopping and dotting outlets to pump fuel. RIL’s divestment of 25% stake in the digital arm to foreign investors to raise over Rs 1 lakh crore in less than two months and the Future Group’s subsequent clash with investor Amazon over sale of the retail business had shades of EM Forster’s 1924 classic, A Passage to India, depicting the tensions arising from the West’s fascination with a mysterious land set against the 1920 independence movement. Even as the Atmanirbhar Bharat packages and monetary support was infusing Rs 30 lakh crore to encourage Make in India, the US’ two fiscal stimuli of US$4.5 trillion and the near-zero interest rates were sending stocks soaring as green shoots of recovery sprouted on a landscape that appeared as desolate as Chernobyl after the 1986 nuclear meltdown. A resurgence of infections and the discovery of a new variant during the last lap of the old year did create doubts about surmounting the challenge like the skepticism greeting the idea of a manned mission in space. With the availability of over 90% efficient vaccines, the obstacles seem as conquerable as in 1969, when the images of  Neil Armstrong gingerly sidestepping the craters on the moon reaffirmed faith in future.

-Mohan Sule

 

The winner takes it all

 

An orderly market rally is spreading out to encompass stocks of different sizes, sectors and ages

 

14 December 2020

A striking feature of the record-breaking market rally is its democratic characteristic. There is order instead of chaos. Unlike in the past bull runs, when buying would be concentrated in frontline stocks in some flavor-of-the- season sectors, investors are spreading their benevolence across the board. Doomsday predictors, true to form, are not impressed. They are out with their usual warnings of bubbles as viewed from different angles such as the market cap-to-GDP ratio, historic valuations and divergence between economic health and trading optimism. Expressions of pessimism amid the giddy euphoria can be irritating. The toll taken by the pandemic has no like-to-like comparison. There was no roadmap to tackle the emergency. The plunge in consumer confidence was not due to runaway asset prices. The fear of an uncertain future without any timeline for a concrete resolution cannot be on par with seven-year cycles of boom and busts. Pumping cash had to be accompanied by progress in containing the outbreak. Supplementing monetary agencies’ determination to keep interest rates zero and buy bonds, which were effective in pulling out the economy from the 2008 mortgage blowout, is the realization by law makers to periodically come out with newer editions of fiscal stimuli. Instead of the one-size-fits-all solution of cheap money and tax concessions that is dusted and brought out during a downturn, the Reserve Bank of India and the clever Modi government have directed resources to the vulnerable, with the potential to become GDP multipliers.

Matching the large-caps’ rebound from the bottom initially, side counters raced past the leaders by the middle of July. Small scrips’ returns more than doubled as against the giants recovering three-fourths and the in-betweens about 85% by early December from the March lows. The mid- and lower-rung players climbed back to growth in 2020 by the third week of October. The mainline indicator managed to swim to the shore the next month. Due to preference for high float and index constituents, it is unlikely entrepreneur-driven entities are a craze among overseas fund managers, who have been net buyers of equities for six of the seven months since April.  With domestic institutions’ shopping restricted to May, reports of bumper profit and enrolments by brokers in the last two quarters point to retail investors occupying vacant spots in the trading ring. The resolves of central banks and governments to support the weak till the pandemic is capped is likely to have emboldened risk-averse individual participants in believing the diminishing downside of volatile bets. Besides profit-booking in big players trickling down the pecking order, percolation is also from segments that stood to benefit from the disruption to those, such as consumption and infrastructure, devastated from the stoppage of cash flow due to lockdowns but eager to roar back on unlocking. The Nifty Pharma index’s January-to-date gains had soared from 14% early May to 50% after five months as the focus on treatment for covid-19 patients shifted to developing candidates to prevent infections. After a slow start, the Nifty IT index had galloped 42% by the beginning of December as businesses rushed to transit into the digital era for contactless transactions.

 

 If drug makers got discounting on actual sales, tech solutions providers’ wealth creation was due to revenue visibility on the premise working from remote locations will persist in some form. The Nifty Energy index’s tanking 39% in the calendar year till early April and eventually bouncing back 6% so far pivoted on the prospect of normalcy in the medium term. The Nifty Auto index’ turnaround, from being a loser after the urban population was confined to work from home to advancing 13% as the year was setting, factored the present and future. Sales of low-end cars and two-wheelers spurred by the desire for personal mobility and the expected expansion of productivity from the December quarter is tipped to lift commercial vehicles. The dispersion of attention is not only between companies of varying shapes and sectors. Legacy and emerging plays are attracting eyeballs simultaneously. If the IPO of new-age Happiest Minds Technologies was subscribed 151 times, that of veteran Mazagon Dock Shipbuilders received bids 157 times, traditional specialty chemical manufacturer Chemcon 147 times and hard-hit consumption play Burger King 150 times the size. It is becoming clear that no industry is going to get shunned. Big and small enterprises, value and growth picks, and innovative and proven technologies will coexist. Policy assistance will be a mix of loose and calibrated measures.

 

-Mohan Sule

 

 

 

Mix and match

 

 

The lesson for Corporate India from the Atmanirbhar Bharat packages and targeted lending is to blend rewards with restructuring

 30 November 2020

Instead of putting to rest the noisy debate about what propels equities, the spree of record highs being notched by local and global stock markets since the first fortnight of November have polarized opinions. The pandemic is showing no signs of weakening. The US tops countries with most infections. The fate of a second stimulus package remains uncertain. Many parts of Europe are once again under lockdown. Implementation of the European Central Bank’s fiscal support is facing obstruction from some European Union members, reluctant to follow the rule of law. India is confronting a second wave after the festive season. Retail inflation has raced past the Reserve Bank of India’s comfort level of 6%. Consumption of food items is at a much faster pace than core sector offtake. The Atmanirbhar Bharat 3.0 tranche did not create any ripples as the series continued with the tradition of making available credit easily rather than any direct cash transfers. Companies’ gradual ramp-up of operations to the pre-covid-19 levels does signify recovery from Q1 June 2020. The question is if they were functioning optimally in Q2 September 2019, the yardstick used to measure capacity utilization, to celebrate the semblance of normalcy. Automobile makers were struggling to dispose of inventory in the run-up to a new fuel-efficient regime. Most others were coping with the credit crunch following the collapse of IL&FS in September 2018 and the subsequent takeover of DHFL by the central bank. Green shoots became visible after the US and China in January 2020 signed a limited phase-1 trade agreement to end their over one-year tit-for-tat import tariff tiff.

What has changed is sentiments. The path is clearing for Joe Biden’s occupation of the White House. The wait for effective vaccines is in the last lap. The trading ring’s resounding reiteration of the appeal of life without face masks and with control over mobility has overridden concerns of last-mile delivery. Forecasts of a global synchronized recovery next year have gained traction. Horrible estimates of economic contraction are now being tempered with the prospect of unlocking of the animal spirits. The reaction is typical of the market that looks ahead with optimism despite a prickly present. Otherwise, stocks would have continued to languish, without, on an average, returning over 50% in the eight months since bottoming out. Neglected components of manufacturing and services such as aviation, logistics, hospitality, lifestyle adornments and tourism are meriting a second look in the hunt for value. Till recently fancied substitutes for remaining connected, shopping and entertainment are being dismissed as expensive. With the grudging acceptance and adjustment to the new normal of movement constraints, the imminent return to the pre-pandemic era, with inequities such as greed, bubbles and bankruptcies, should have  either been met with skepticism or a jolt of shock. The enthusiastic response reinforces the typical trait of the market to find redemption in a hopeless situation or to become despondent even when the setback is temporary. The behavior post reduction of interest rates by the central bank on projection of lower GDP growth, for example is not predictable: jumping with joy at the availability of cheap money or turning glum on worries of dip in demand for several sectors.

 

If there is any redeeming quality to the bout of sluggishness, in the absence of an adrenaline fix, alternating with irrational exuberance, on the approaching release from home confinement, is India’s calibrated moves to tackle the crisis. As the RBI was releasing cheap credit so necessary for risk-taking, the Narendra Modi government was simultaneously undertaking structural reforms. Targeted lending to farmers, home buyers and small and medium enterprises were matched by freeing the agriculture sector to sell produce anywhere, simplifying labor laws and linking incentives to output. Liquidity injections have been measured and selective, mainly aimed at farmers and urban poor. The outcome is becoming visible. The lure of no-cost loans will accelerate the shift to the organized sector that was being encouraged by lacing the GST with the incentive of input tax credit. The enlarged tax-payer base will enable focused addressing of weaknesses. Production as a pivot junks the concept of tax holidays to attract investment and acknowledges the importance of scale in manufacturing. There is a lesson for companies and investors. Dividends, buybacks and bonus shares need to be accompanied by capital expenditure for boosting market share to ensure that the rewards are sustainable. A crisis can be an opportunity to empower stakeholders to make them meaningful contributors to wealth creation.     

-Mohan Sule

Repent at leisure

 16 November 2020

The Amazon-Future Group tiff has exposed the downside of foreign investors’ lifeline to Indian companies

 

There are many reasons a company feels compelled to issue shares to non-promoters. The need for funds to undertake expansion to grow is among the chief. Resorting to debt has limits. Servicing chips away large chunks of cash flows. The IPO expands the equity base. It is an expression of confidence that the earnings per share will not only keep pace with the dilution but will justify the discounting. Listing provides an exit route to angels and venture capitalists, who have reposed faith in the promoters, at hefty gains. Tucked in at the end is the benefit of visibility. A good financial performance and a bright outlook attract more investors. The increase in demand helps to market future offerings at a still better premium. Even an offer lower than the ruling market price goes to fortify reserves to dip into during emergencies or reward loyal shareholders during difficult times. Corporate actions can range from buybacks to bonus shares. A high dividend yield can stem a stock’s slide that might be due to macro factors. These upsides are accompanied by responsibilities. The first is complete transparency by disseminating information that can be trivial as well as grave. The need-to-know can span changes in senior managerial personnel, plans for mopping resources, restructuring and launch of new products besides deliberations of board meetings and interaction with big-ticket investors. The idea is to put in public domain anything that might influence price movements.         

 

Many segments come under the purview of two regulators after a float. Banks operate as per the guidelines issued by the Reserve Bank of India and the Securities Exchange Board of India. The Department of Telecommunications and the Telecom Regulatory Authority of India as well as the market regulator have oversight on telecom services providers. The Competition Commission of India weighs in on acquisitions and Sebi on open offers to take the process forward. Ensuring uniform treatment to all classes of investors is expensive. Some of the grumblings about the cumbersome procedures have been acknowledged. The playing field now factors the problems of issuers apart from investors. Truncated balance sheets are permitted to capture the salient financial features instead of cramming with inconsequential data to meet reporting requirement. Funds can be raised in a matter of days unlike the earlier drawn-out drill. The period from closure of issue to debut has been shortened. After weighing the cost-return of staying in the trading ring, some eventually decide to retreat from public gaze. They delist. A majority are at in mature industries. The business model is not a cash-guzzler. If companies are discovering the downside of access to easy money, of late they are realizing how dangerous the charm of foreign investment can be. Currency fluctuations knocking down dollar-denominated returns and tightening of liquidity back home can trigger a sell-off. International participants demand compensation to claw back the loss suffered on revelation of governance missteps. Drug producers have been dogged with patent infringement litigations. Tech solution majors have faced class action suits for concealment of frauds and depreciating costly buys. ADRs on Nasdaq and NYSE require additional compliance with the SEC.

The arbitration court in Hague end September ruled against the Union government on retrospective taxation including interest and penalties amounting to Rs 22000 crore levied on Vodafone for not deducting tax source on the US$11-billion payment for 67% equity of Hutchison Whampoa’s India mobile business in 2007. The latest flashpoint is the enforcement of contract between the Future Group and Amazon of the US, with about 5% stake in Future Retail after it bought 49% in holding company Future Coupons for Rs 1500 crore in August 2019. The US e-commerce giant has contended the Rs 24700-crore deal to sell the brick-and-mortar outlets and the logistics and warehousing businesses to Reliance Industries contravened non-compete agreements. The ramifications of the case will be felt beyond the two squabbling partners. A prolonged legal battle will put a spoke in the plans of India’s most valuable company to expand the physical presence and merge the synergies with the digital prowess to emerge as a formidable cyber market-force. Crucially, the valuations demanded from foreign investors for exposure to the retail venture might have been based on the recent acquisition. For investors chasing companies pulling in dollars, the stakes could not be starker: riding the exuberant sprint or fearing the pain of a sprain.

 

-Mohan Sule

Beneath the surface

 

What macro indicators are missing: the uneven revival in the initial stages is set to spread out

 

 

Those looking for a one-way trend of macro indicators to validate their investment strategy are likely to be disappointed. Retail inflation in September was beyond the central bank’s comfort ceiling of 6%. Industrial production decelerated to 8% from 1.4% in August. Stagflation is considered one of the worst types of afflictions for an economy. A stimulus can unleash prices. Pushing up interest rates to curb the runaway consumer affordability index hurts producers at a time they need support. What is particularly puzzling is the mismatch of activity at factories with unlocking entering the fourth phase in September. The first batch of corporate results indicates month on month ramp-up in operations to reach the pre-March levels in the last month of Q2. Yet the output of manufacturing, mining, power generation, capital goods and consumer durables and non-durables contracted. There are two explanations. The release of the bottled-up demand is not uniform. Spends are going towards easing living and resuming servicing of liabilities. The other interpretation is the preoccupation of sellers to dispose of inventory and execute pending orders. Surplus, if any, is getting deployed in safe-haven gold, up to a historic high of Rs 55845 per 10 gm in August, to protect the downside and in the stock market, clawing back 56% from the March bottom, in the hope of replenishing depleted reserves.

After food and hygiene, staying connected and solvent appears to be a priority.   Terrestrial and sub-sea cable network operator Tata Communications’ 680-basis-point margin expansion in the trailing 12 months was largely due to data traffic. Operating profit of tech solutions providers TCS, Mindtree and Tata Elxsi kept pace with galloping revenues from operations. Market outperformance by Muthoot Finance, with over 100% returns, and Manappurum Finance, gaining 77%, from April till the third week of October suggested leaning on gold to bridge the liquidity gap. Kerala-based CSB’s annualized profit before tax surged 150% over the past year, with advances against bullion galloping 47%. The unevenness of the recovery was pronounced in the automobile sector. Though industry-wide buying of commercial vehicles was down nearly a third from September 2019, Tata Motors’ passenger vehicle offtake sprinted 162%. Escorts’ agri-machinery recorded the highest-ever September sales. The partial resumption of cash flow on gradual lifting of restrictions found its way to lenders. Bandhan Bank’s collection efficiency was 92% in the month after the moratorium on repaying loans ended in August. That suspended purchasing is returning was confirmed when real estate developer Sobha’s total average realization, without any new launches, raced past five quarters. Reaffirmation came from the sparkling show put up by manufacturers of cement, an important measure of economic health. ACC’s ready-mix concrete sales volumes spurted 76% and Ultratech Cement’s pre-tax profit soared 65% as against year-ago quarter. Their robust margins reflected the willingness of the market to absorb higher prices. Tata Steel had to cut down on exports to meet historic domestic quarterly deliveries.  

 

Non-elastic usage is poised to trickle to discretionary consumption. World’s largest producer of air-coolers Symphony launched a new range of industrial and commercial applications in an act of optimism. Titan Company’s jewellery division’s recovery rate was 98% in Q2 from a year ago. Some companies have hinted of a future even brighter than the satisfying present. After reporting sequential operating growth, Infosys guided for higher revenues and margins for the full year. Wipro projected the momentum of IT services to continue in Q3. Apart from forecasting scaling up in each of the remaining two quarters, HCL Technologies estimated 20%-21% more operating profit for the entire fiscal year. Even companies in struggling sectors are offering earnings visibility. KEC International’s fresh EPC recent orders constituted 2.5 times consolidated June2020 quarter sales. Welspun Corp’s deal book bulged to six times standalone Q1 top line after multiple wins of Rs 1400 crore to lay pipes. Transport infrastructure player Ircon International’s contracts ballooned to 5.6 times consolidated turnover of the first three months of FY 2021. Investors seem to have spotted the trend the headline numbers missed. Broker IIFL Securities’ bottom line more than doubling and online platform 5Paisa Capital’s record client acquisition in the latest quarter, boosting fees nearly twice that a year ago, capture the upbeat mood.

 

-Mohan Sule

Sagacity v stupidity

 

When OFS at a steep discount to rich valuations is foolish but giving up undervalued shares at a hefty premium is wise

 

Happy days are here again for investors. They are spoilt for choice. The options for deploying surplus to earn returns beating low-yielding fixed income instruments include IPOs, FPOs, OFS and rights issues from companies in sectors ranging from tech services, financial services, chemicals, banks, capital goods, media and entertainment,  and PSUs.  Buybacks and delisting are opening avenues for monetization of assets. Bonuses and dividends are suggesting still better earnings ahead. Large-, mid- and small-caps have recovered more than half from their March lows. Shaving off a near quarter of the GDP in the April-June period due to a complete, 21-day nationwide lockdown has been shrugged off as the bottoming of the economy that is since June unlocking bit by bit. In previous instances of economic contraction, only the defensives seemed appetizing, and that too for their dividend yields. Now buying is spread to tech players for their role in connectivity, producers of cheap generic drugs, pockets of automobiles coming back on track due to rural prowess propped up by a bumper rabi harvest and easy credit, chemical makers reaping the benefits of good rains and metal  manufacturers as factory operations resume.     

 

Investors have never been more confused. The choices available call for suspension of belief or junking of time-tested strategies. State monopolies look attractive in the absence of competition. With privatization being embraced even in defence to become self-sufficient, doubts about the sustainability of the pole position cannot be brushed aside. Emerging businesses have no comparable Indian peers. Their uniqueness disappears on realization that customers are based in mature markets. Deal wins hinge on undercutting rather than on superior technology. The high discounting demanded by those entering a crowded field, often more than legacy businesses, is like flipping a coin: Re-rating for established enterprises or an indictment of the flattening growth after decades-long existence. Investors have a difficult task. Bumper gains by hitching on to those spotting gaps in the market comes at the cost of reshuffling the portfolio by shedding similar assets to ensure that weights assigned to different sectors remain undisturbed. The outcome of being taken up by the conventional theory of the track record being a guide to the future can mislead. The FPO of a private bank, facing a run a few months earlier, received a warm reception from institutional investors despite being hawked 51% below the traded price, perhaps drawing comfort from the 30% premium to what a clutch of public and private banks had plonked three months earlier in a government-shepherded rescue. The stock, which was up 250% even at the bleakest point post the strategic investment at 61% off the level just before the outbreak of the current pandemic, is hovering near the issue price. Instead of being an opportunity, a low-cost entry can be a trap. Presence of quality investors can be an assurance as well as a bait.

Increase in the number of shares available for investing should ideally lead to better price discovery. The understanding received a rude jolt after the co-owners of an MNC subsidiary offered do divest part of their stake at 33% discount to the market quote. At first glance, the move smelled of desperation for funds. Not only that, knocking down the valuation by one-third sent a message of no-confidence in the historical performance of absolute  2,600% returns to the Rs 6900 level in five years and P/E in triple digits even as revenues recorded a modest CAGR of 20% in the period. Rewind to a few days earlier, and some clarity emerges. The Indian company wanted money to acquire the parent. Instead of lauding the controlling stakeholders for being realistic about the impact of the 25% float on valuation, there was a stampede to exit. The oversubscription, once more driven by big-ticket funds seemingly attracted by the projections of revenues to go up 40% and the operating margins to 16% from 13% in four years, encouraged the promoters to bump up their offloading to 20%. Another unlearning was about cutting losses. If the ordinary shareholders of a tech solutions provider had followed the dictum and not stayed put despite range-bound price movements for more than two years, mediocre returns ratios, sluggish sequential revenue growth and industry median margins, they would not have reaped 78% gains in the three months since delisting was announced and completed. The victory might turn out to be illusory after figuring out if the willingness of the British equity group to pay 67% more than the indicative price, which was 37% above the annual bottom, suggested the possibility of being short-changed.

 

 -Mohan Sule

 

Home run

 

RIL’s stake-sale in the domestic digital and retail ventures underlines the indispensability of foreign capital        

 

If a stock returning 63% in five months, when the mainline index improved about 20%, is value unlocking or value bubble has divided the market. The debate has intensified particularly after Nasdaq shed over 10% from its peak reached on the back of work-from-home communications facilitators early September. Technology proceeds comprised just 2.5% of Reliance Industries’ headline turnover last fiscal year. Refining, petrochemicals and oil contributed nearly three-fourths. The frenzied fund-mopping spread over four months since end April, however, resulted in the digital holding company constituting about 30% of the consolidated market cap, roughly corresponding to the 36% gain of the counter in the period. Fourteen global players, ranging from social media giants, sovereign funds and shrewd big-ticket portfolio managers, committed over Rs 1.5 lakh crore to the cyber-cum-telecom-based properties for 23 times FY 2020 revenues. World’s most valuable company Apple was trading at 5.76x FY 2019 ended September sales when it reached the historic US$2-trillion market cap in August. Google’s parent Alphabet was recently quoting at 5.7x 12-month ended June 2020 offtake. After a  seven-week gap, when India’s most valuable company bought the footfall-, storage and logistics-related businesses of the Future group for Rs 24713 crore, the money-infusion exercise restarted, with three overseas angels together picking 4.25% expanded equity of the retail venture for a total Rs 18600 crore. The modest equity valuation of 2.62 times receipts of the preceding financial year has translated into about 1.6% lower market cap than of the mobility and interface streams. The higher premium to 11% of sales and half the operating profit of a brick-and-mortar presence at a crossroads of real and virtual world  can be taken either as the road ahead in the post-pandemic economic order or a throwback to the dotcom bust in 2000.

 

Irrespective of the outcome, Mukesh Ambani has set the template for how Corporate India can snatch victory from despair. Facebook front-lined a fat-cats’ parade when Brent crude had plunged below US$20 a barrel. The strategy of diverting attention from the sluggish core to promising sunrise enterprises looks as controversial as the Federal Reserve’s opening up of no-cost liquidity tap after the September 2008 credit crunch that marked a bold but workable departure from the boilerplate prescription of belt-tightening prevalent since the Great Depression of the 1930s. That the framework is being relied upon to deal with the wrath of God is a testimony of its durability. Another takeout is there is no substitute for capital. A first-mover advantage can be overcome if there is a treasury chest. Reliance Jio Infocomm became the leading cellular services provider by subscribers in a little over three years since launch in September 2016 by giving voice calls free and data at the lowest cost anywhere in the world. The parent achieved the feat at a price tag of Rs 1.5 lakh crore. Even as net liabilities were getting demolished by divesting 33% control in the online arm, a benchmark was being set for an imminent IPO, something that would not have been possible had the high-cost debt been refinanced at zero interest rate. Instead of replenishing of treasury, inflows would have turned into outflows to service the loans. A setback was turned into a virtue.

Too many investors are not a crowd. Only a couple of the benefactors own slightly more than 2% each of the RIL subsidiary. Two internet giants will hold around 18% of the diluted capital between them, a figure that can collect more followers rather than posing a destabilizing factor. Many of them are likely to exit during listing at a hefty gain. Right now, the shareholders are admiring the agility in underwriting growth, brushing aside the confusing complexity. Will Jio Mart run by Jio Platforms compete with or complement brick-and-mortar Reliance Retail operated by Reliance Retail Venture is not clear. The lack of clarity on cross-subsidization of offerings is unlike the easy-to-understand oil-to-chemicals businesses, whose performance hinges on efficiently producing fuels and polymers. Consumers enticed by cheap basic services are expected to be lured by the click-and-bait higher-margin fare on a crowded menu, whose tariffs will have to be constantly revised to preempt or react to competitors. Investors’ impatience with the flat trajectory of the stock for over eight years since mid-2009 amid concerns of the overhang of nascent diversifications had to be quelled by a 1:1 bonus over three year ago. The test will be the discounting that the standalone entities will grab.

 

-Mohan Sule

Divergence to convergence

Law makers and regulators are getting on the same page for ease of doing business without bothering about the bill

 21 September 2020

Ever since the US Federal Reserve shifted its gaze last month from inflation-targeting to job-creation, the role of policy makers and market monitors has come into focus. Before the pandemic, there was no confusion on what was expected of governments and various regulators. Elected representatives making laws that turned their nations into welfare states or were so restrictive so to stifle entrepreneurship had to face the backlash of higher purchasing spends and low growth. The problem is that the terms of most democratic governments range from four to five years. The scope to inflict damage due to recklessness or timidity is extensive, requiring painful adjustments by the next regime. Regulators balanced populism and conservatism by calibrating policies that tightened or eased rules. Central banks tinkered with the flow and cost of money to discourage exuberance or encourage consumption, while keeping food and non-food output affordable. Efforts of the securities monitors were to create a level-playing field for issuers and investors. Competition regulators nipped predatory pricing and unfair sales practices to ensure users had a choice. With such clear-cut spaces to operate, there should be no recession, runaway retail prices and speculative bets. Each segment should have a handful of operators enjoying similar share of the market. Insider trading, stock-rigging and accounts fudging should be the rarest of rare cases. Unfortunately, textbook rules do not account for changes in technology and tastes. The IMF and World Bank prescription of belt-tightening for government excesses has become outdated. Now the template is more liquidity to boost consumption.

The pandemic has blurred the boundaries between the functions of legislators and gatekeepers. Ideally, they are supposed to work at cross-purpose without paralyzing the system. If the government adopted loose fiscal habits of cash infusion, soft taxes and high expenditure to support the distressed economy, the monetary authority was expected to make funds dearer to nip any bubbles in the making. Right now, both the arms are working in tandem to make available low-cost loans. In fact, the Fed has strayed from its mandate to boldly trespass into a domain that is not in its charter. It will keep the tap of cheap credit turned on for as long as it takes to achieve saturation employment and retail demand to outstrip supply by 2%. The Reserve Bank of India is in no mood to bump up the real negative interest rates for fear of stalling economic recovery. After the Rs 50000-crore targeted refinancing in May, NBFCs were offered another Rs10000 crore in August. Servicing of term loans was suspended for six months, an action best suited for politicians. Easing of asset classification was permitted to offset provisioning for covid-19 defaults. A one-time restructuring of loans outstanding before the medical emergency is set to be followed by sector-specific prescriptions.  Priority sector lending norms have been tweaked to include education and social infrastructure. Flow to credit-starved districts will earn incentives.

 

The capital market watchdog turned endearing from brusque. Preferential issues at higher of the volume-weighted average price over 12 weeks or two weeks cleared the way for cash-starved Corporate India to tap into the US and India stimulus. Scaling down the minimum market cap of public holding in a rights issue to Rs 100 crore from Rs 250 crore, threshold for subscription to 75% from 90%  and prior listing to 18 months from three years have provided flexibility to promoters to increase their exposure to support their companies. Doing away filing of draft offer for rights issues up to Rs 25 crore is to help small enterprises. The roll-back of the gap between buybacks to six months from one year opens the exit route for the shareholders.  Side-pocketing of stressed assets can be done the moment a proposal for debt recast is received by the fund house, thereby stemming the erosion of NAVs and redemption pressure. The clampdown on multi-cap funds and end-of-the-day margin in the cash segment plugs another loophole for manipulation. Instead of lazy investing of concentrating on large caps, fund managers need to take exposure evenly across different categories of stocks or allow investor migration. Brokers can no longer misuse shares pledged for rampant intra-day trading as each transaction has to be accompanied by adequate backup. What needs to be seen is who is going to pick the tab for the ballooning bad loans and loss of price discovery coming as accompaniments in the feel-good feast.

 

-Mohan Sule 

 

New beginnings

 

Emergence of strong companies on clearing of regulatory overhang, capital-raising and restructuring

 7 September 2020

 

The June 2020 quarter sharpened Corporate India’s fault lines by separating companies into three categories. Essential services providers did not have to shut down. Nevertheless, volumes and the margins contracted on a sudden slump in demand, with export-oriented pharmaceutical producers and tech solutions providers being the exceptions. In the middle were a majority, with no output in April and a gradual recovery from May to about 80% capacity utilization by June. Some of them put up a decent show by restricting the fall in the margins due to soft input costs and dip in fixed overheads on reduced operations. Rural consumption partially compensated the absence of urban buyers. The worst of the lot were those who had to bear the full weight of social distancing and included malls, multiplexes, airlines and tourism- related services. A common thread binding all is the focus on survival rather than growth. Capital expenditure is the casualty as cash is stocked up.

Going beyond the headline numbers, three trends became visible, reaffirming the assumption that a downturn is the time for new beginnings. First is the clearing of the overhang of past issues that had spilled over from the pre-covid-19 period. The pullback of Yes Bank from the brink is a stunning example of how a crisis can be converted into an opportunity by taking advantage of the cheap liquidity looking for deployment. The risk-takers, the clutch of public and private lenders pooling in Rs 10000 crore by subscribing to the shares at Rs 10 mid-March, had made a notional profit of 50% on their investment in five months, giving an annualized return of 120% when real interest rates are negative. Besides returning to profitability after reporting losses in the past three quarters, Q1 showed sequential improvement in operating parameters. Customers repaid almost 50% of their overdue position, enabling repayment of 35% of the Rs 50000 crore borrowed from the Reserve Bank of India. Credit ratings on foreign and Indian currency borrowings have been bumped up. The regulator’s nod for a new top boss of HDFC Bank and Bandhan Bank coming out of restrictions on branch opening since September 2018 after promoters brought down their stake by half to around 21% contributed to the rerating of the banking sector that got a further boost after the central bank allowed one-time restructuring of  loans outstanding  in March. The turnaround in sentiment was also an extension of the record Rs 56500-crore capital-dilution by Yes Bank, ICICI Bank, HDFC and Axis Bank as India was unlocking. IT, real estate, auto and pharma players, too, are tapping the equity and debt markets. Shares are being offered at a discount to the current prices, off their yearly highs, leaving scope for appreciation once spends on growth resume. Sovereign funds besides venture capitalists are taking exposure. The exercise offers clues to the shape of the issuer. Private placement indicates the support price for the stock. Retail investors through FPOs can enter at levels lower than those of institutional investors. Rights issues usually imply lukewarm reception from new investors. At the same time, they demonstrate promoters’ commitment. Debt implies short-term need for money. Several companies are accessing credit at a coupon of around 8%, implying real borrowing cost of 1% considering consumer price inflation is a tad below 7%.

 

Change in ownership is another offshoot of any churn in the market.  The amalgamation of 10 public sector banks into four from 1 April, at hindsight, preempted what would have been inevitable in the post-pandemic era. The merger between ICICI Lombard General Insurance Company and Bharti Axa General Insurance Company is a forerunner to the consolidation in the financial services segment, just like in the telecom space, where only three participants remain. A shakedown in the distressed realty sector will leave only companies enjoying investor confidence. The Embassy group’s friendly takeover of Indiabulls Real Estate was not surprising. A 10% equity stake was divested to the new promoter last year as part of the effort of the troubled group to clean up the balance sheet in the run-up for  approval to combine the financial services arm with Laxmi Vilas Bank that is now not happening. Economic turmoil is the right time for unwieldy conglomerates to become lean. The hiving of the non-airport businesses by GMR Infrastructure was in response for pure play to assign proper discounting. Privatization and connectivity in the civil aviation sector is one of the thrust areas of the Modi government. Investors can, thus, look forward to a fitter Corporate India readying to take off.

 -Mohan Sule

The four musketeers

 

Pharma, IT, auto and commodities gain amid unusual circumstances, hoping they will benefit in ordinary conditions

24 August

Undoubtedly, Reliance Industries led the market recovery from the pessimism of end March lows. The apparent ease with which the petrochemicals-to-retail conglomerate amassed over Rs 2 lakh crore from more than a dozen big-bulge investors and own shareholders within three months paved the way for other Indian companies to issue equity and debt. Importantly, domestic investors felt confident of the Indian economy’s outlook. After all, Facebook, Google and the Saudi Arabia and the UAE governments will not be taking exposure to India’s largest company by market value if they did not see growth visibility. In the ensuing euphoria, the contribution of several wealth creators did not get adequate attention. Those not enamored by the leveraging of the telecom platform to connect farmers with consumers through mom-and-pop grocers looked majorly at four sectors benefiting from being at the right place at the right time, turning of the wheel and having nothing further to lose. The coronavirus outbreak opened up an opportunity for one, while cash injection in export markets supported another. Clearing of regulatory overhang and anticipation of recovery following the easing of lockdown restrictions propelled the others. Ironically, a return to the pre-pandemic period might disrupt the dream-run of these outliers.

 

The current medical emergency enhanced the visibility of drug producers. Interest in sanitizers and malarial antidotes surged. Many were quick to develop and launch anti-viral remdesivir to treat covid-19 patients. The margins got inflated on dollar earnings, aided by a weak rupee. Not only is the pharmaceutical sector one of the three to provide positive returns in the current calendar till date, its appreciation has been the highest. Intensifying competition in the regulated generics markets and US President Donald Trump’s order to import drugs for senior patients with the lowest prices from economically comparable countries are potential disruptors. Several players are looking to Latin America and Africa, where demand is plenty but scope for the upside limited, to diversify risk. Not only that, the overarching FDA blocks imports from plants falling short of its exacting quality standards. Lengthy and costly litigations for patent infringement have concluded with millions of dollars in settlement. The sustainability of the current business model is uncertain just as it was for tech solution providers prospering on back-office work.  Shift to work-from-home and contactless selling have hastened the transition up the value chain. Their future appears bright as the reliance on the digital mode for communication is likely to be the new normal as captured by the bumper earnings and soaring valuations of US internet properties. Revenues of investment bankers in America and local brokers got a bounce as restless investors took to online trading. The downside will be pressure on operating profit as more players enter the fray and dip in consumer confidence if an effective vaccine is not available soon.

The pain of piled-up inventories on automobile manufacturers in the run-up to the BS-VI emission regime has disappeared. Expectation of increased footfalls to snap up new models was dashed after the nationwide shutdown end March. Two-wheelers and tractors, riding on rural prosperity following a good rabi crop and timely arrival of southwest monsoon, are showing traction but not commercial vehicles.  Despite localized lockdowns making transportation challenging, investors betting on buying to catch up going ahead pulled up the Nifty Auto index to third-best performer, beating the benchmark from July till date. Similarly, the upturn in commodities is discounting consumption coming back as the mortality rates drop. From below US$20 a barrel level in April, Brent crude has more than doubled. Metals are crackling as the US and China signal slow but gradual rebound. Hike in MSP and ease of credit to farmers have bolstered profit of fertilizer and pesticide makers, with the Nifty Commodities outpacing the mainline indicator over a month. What is common with these sectors is their lackluster performance before March. Now they are basking in an extraordinary situation in the belief that they will get their rightful dues on the restoration of the old world order. With pharmaceutical stocks slowing down over the past few days, what will be keenly watched is whether they will be able to maintain their momentum or return to their traditional roles as cyclicals and defensives as other laggards pick up speed.

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 -Mohan Sule

 

 

 

 

A new order

 

Making of a welfare state, disruption policy by companies and cash getting better discounting

 10 August

 

The pandemic has not altered the world. It had already begun to change a dozen years ago. What the outbreak of coronavirus has done is to make the transformation irreversible. From turning unmistakably risk-driven, when China opened up its economy in the early 1970s and early 1980s, more and more countries are becoming welfare societies, acknowledging the limits of market forces. The 2008 global securities meltdown was triggered by reckless lending. Instead of turning tight-fisted, the US central bank’s remedy was giving away money at practically no cost to keep companies running. In 2020, the Federal Reserve’s bond-buying has been supplemented by the US administration’s direct transfers to substitute pay cheques. Pump-priming is now set to become a precedent of what to do when faced with an economic disaster that could be man-made, as in 2008, or a medical emergency as in the present day. Differences in US Congress or the EU are not about the need but on the quantum of support. The concern of monetary authorities is not their balance sheets but keeping the credit pipeline open. The initial scepticism of asset bubbles has given way to grudging recognition of the effectiveness, when nearly all the employable people in the US got jobs. Not surprisingly, stakeholders expect the second act to replicate the first, despite an uncertain timeline for the availability of vaccine. A bull-run is set to be the new normal irrespective of the reality of the economy. The new-age of socialism is with capitalist characteristics.

As developed nations watch helplessly the surge of patients overwhelm their healthcare system, businesses, too, have to reckon the reality that covid-19 is here to stay. Strategies that produced results in the past will not necessarily have the same outcomes going ahead. Huge capacities to achieve economies of scale for competitive pricing are likely to be a disadvantage if the site is in an area that has borne the fury of the calamity. Backward and forward integration, a favored recipe for cost-effective production, will be meaningless if distribution of finished goods poses a logistical problem. Proximity to raw materials or markets to circumvent poor connectivity can be a winning strategy only if the back- and front-ends of the value chain function simultaneously. To overcome, a smaller but self-sufficient presence across regions might emerge as a preferred option. Outsourcing will accelerate as niche suppliers will have the agility to keep ticking. Work from home, contactless shopping and home delivery will be an opportunity to become asset-light. An important challenge will be ensuring working capital at a time revenues have decreased or disappeared. The decline in the cost of borrowing accompanying the economic turmoil will be used to pad up treasury. Rationalising overheads will be the method to maintain or even expand the margins instead of pricing power. Of course, soft input expense on drop in commodity prices will be a major contributor. Cash and equivalent will assume a prominent position. Debt issuance and equity dilution will be frequent to suck in the liquidity sloshing around, without being a source of worry for the impact on profitability. Growth expectation will also have moderated as real interest rates become practically non-existent.     

Besides governments and companies requiring a new vision to prepare for unexpected shocks, investors will have to re-examine their strategies. They will have to scrutinize revenue streams to determine segments vulnerable to discretionary consumption. The distaste for lots of reserves, signalling lack of opportunities, for dragging down the return ratios will have to be muted. How fixed expenses are managed when sales dry up will be a topic of interest. The pressure for ramping up dividend pay-outs has to be tempered as a trade-off for remaining a going-concern. Priority to survival over capital spends will be lauded. Valuations will be pegged to access to cheap funds than earnings growth. The government could even impose capital adequacy on the lines of banks. Despite protests, investors have come to accept the 2% spend of the three preceding years’ profit on corporate social responsibility. The buffer might even act as collateral for short-term loans. It will not be surprising if the DRHP of IPOs spell out how much of the proceeds will be kept aside as security. The market might even be willing to assign higher discounting to such prudent issuers. Importantly, enterprises will be expected to spell out in the annual general report policies and systems in place to cope up with future disruptions.

 

 -Mohan Sule

 

 

Making up for lost time

After being left out of the 2010s global equity boom, the Indian market does not want to miss Bull Run 2.0

27 July 2020

Equities have rebounded swiftly and strongly from the end March lows. There are enough clues to suggest it is a making of a V-shaped recovery rather than a dead cat bounce before the beginning of a bear phase. India missed participating in the over-decade-long bull-run enjoyed by the US, fuelled by near-zero interest rates and the six-year long US$4-trillion bond-buying by the US Federal Reserve after the collapse of Lehman Brothers in September 2008.  India was grappling with its demons. The Supreme Court in February 2012 cancelled the allotment of 2G spectrum, leading to a policy paralysis in the run-up to the Lok Sabha elections in May 2014. Coal block nominations, too, were held invalid in August 2014. Reserve Bank of India governor Raghuraman Rajan in December 2015 ordered banks to undertake asset quality review, with the threat of 5% provisioning for under-reporting. Lenders became risk-averse after they were told to keep aside 15% of their deposits, instead of 5%, for bad loans, whose classification was narrowed to 60-day default in servicing. The Real Estate Regulatory Act in May 2016 pushed the largely unorganised industry into turmoil, affecting demand for housing-related products including aluminium, steel and cement as well as for home loans. The recall of high-value notes in November 2016 and the bumpy transition to the goods and services tax era in July 2017 followed by the apex court in October 2018 ruling that the automobile sector had to transit to a new, fuel-efficient era from April 2020, slowed down private investment. The   collapse of infrastructure player and financier IL&FS in September triggered a liquidity crunch that lingered well into Q3 of FY 2020. Green shoots of recovery visible in January and February were nipped in March following the covid-19 outbreak.

In a strange coincidence, the Fed is mimicking its 12-year-old act as it scrambles to contain the damage to the economy from the pandemic. Interest rates are back to near zero. Bond-buying has resumed and will continue, at least well into the next year. The US government has provided US$ 5.5 billion of cash through two stimulus packages, in March and May. The stage has been set for Bull Run 2.0. In India, the overhang of the past disruptive measures has faded. The low corporate and individual tax rate regime has come into effect from the current financial year. The Rs 21-lakh fiscal and monetary support may be low on direct cash transfers but has opened up easy and cheap credit to the important components of the economy such as farmers, small and medium businesses and the home, auto and consumer durable buyers. The entire economy has been opened up. There has been no better time for risk-taking than now. The capital-raising being undertaken across the spectrum suggests that companies are feeling emboldened despite lack of revenue visibility. Not many are undertaking capital expenditure at this juncture. What is important is the confidence of issuers that money is available and the optimism of investors that it will be put to good use in the near future. The cash chest built at low interest rates will be an advantage when normalcy returns.

The readiness to part with funds is a useful guide to big-ticket investors’ calculations. RIL raised nearly Rs 2 lakh crore in less than two months from a clutch of foreign companies, equity funds, sovereign funds and internet properties to service the domestic digital and fuel markets, and not for exports. It suggests the bets are on India to regain its title as the fastest-growing economy in the world. That it will be the only major economy, excluding China, to record the lowest GDP de-growth in the current fiscal year points to, apart from a low base, resilience even in the most adverse environment. Right now, rural consumption is supporting the Old Economy and partially offsetting the absence of the urban buyer. It will not be surprising if Mukesh Ambani has used the presence of   Reliance Retail in tier 2 and lower centres to attract funds for the creation of a virtual marketplace that aims to replace the brick-and-mortar model. Only RIL can pull off this seemingly contradictory achievement. In the process, the buoyancy in the secondary market as India’s most valuable company turned debt-free has embraced sectors with physical assets such as automobiles, capital goods, infrastructure and commodities, positioning them to be beneficiaries when normalcy return. It is a welcome departure from the previous experience of demand drying up for all goods and services, save for the sluggish defensives, during a recession. A virtuous cycle is being created. Every secondary market rally will see renewed fund-raising in the primary market. The correction in listed stocks will afford an entry into reasonably valued counters.

-Mohan Sule

 

 

 

Lost in messaging

An FMCG player’s rebranding exercise, decoupling of gold from inflation, and India’s move to self-sufficiency confuse

It need not take a dot-com bust, credit crunch or pandemic to send investors back to the drawing board.  A sudden corporate action, an unexpected transformation in the relation between economic indicators and off-the-track policies in response to emerging situations can merit a reexamination of the traditional strategies to chart out the outlook based on past experiences. The market, not surprisingly, shrugged off HUL’s decision to replace the prefix of its fairly popular beauty-enhancing label. The FMCG sector had an eventful run in the two years since CY 2019, with the Nifty sector index returning over 45%. Defensives were favored due to the turmoil caused by the transition to the goods and services sector from 1 July 2017 and the drying up of liquidity following the collapse of IL&FS in September 2018. The lockdown to contain the covid-19 outbreak has disrupted front- and back-end operations. Worse, only health and wellness concoctions, with margins in high teens, are seeing brisk sales as the personal-care range, with over 20% cushion between input costs and retail prices, languish. With reported bumper sales of 10% of the total turnover, India’s largest FMCG player has made cosmetic changes to a winning formula without junking the underlying messaging of putting a premium on appearances. The shift from a niche segment, implying hefty mark-up, to mass market, with thin profitability, should prompt questions from institutional investors. The aim to be inclusive should draw the attention of regulators and consumer protection agencies to probe if there was mis-selling earlier. Any rebranding exercise is an admission of a goof-up. Instead of using the current slump in consumption to gradually phase out the politically incorrect adventurism, huge expenditure will be incurred on repackaging when the road ahead lacks visibility. The move will affect similar products of peers and should trigger a de-rating of the sector.

The rise and rise of gold is equally confounding. The precious metal is sought as a hedge against inflation. Historically, crude has been a major contributor fuelling food and non-food prices. Growing exposure to commodities is linked to acceleration in economy activity. The US currency loses appeal. Though up from its record low in April, oil is half way off from the US$80 a barrel mark that is needed to sustain the economies of petroleum exporters. The dollar index soared in March as infections spread in America, leading to a lockdown. The greenback displayed strength at a time the shutdown was expected to extract a heavy toll on employment. The benchmark has come off from the highs but is back at the early 2020 level, when businesses were roaring, due to cash infusion by the government and the Federal Reserve. If the chasing of bullion signals fear of the future, the consolidation of the ultimate trading converter suggests complacency that policy makers and monetary authorities will do whatever it takes to keep the stock market buoyant. Easy money is hedging its bets. That both are being viewed as safe havens in times of bullishness and distress in equities is the new reality that has to be factored in while making wealth allocation.             

The slogan of Aatmanirbhar Bharat is as euphoric as it is problematic. Self-sufficiency is admirable but will spell the end of global trade that is based on the assumption that investment goes where returns can be maximized.  If a barrier-free movement underwrites prosperity, it also poses a threat as markets get linked, increasing inter-dependence. Government role in ensuring all requirements are produced locally can come at the cost of social spending. Labor, land and raw materials might be available at home but not capital. A mass seller of passenger vehicles is owned by a Japanese corporation. Nobody is sure who the owners of India’s largest infrastructure player or the second largest tech services provider by market value are because of their dispersed shareholding. An aggressive telecom services provider recently sold nearly 20% equity stake in its digital arm to overseas equity funds. Many of our pharmaceutical exporters and auto manufacturers will need huge funds to replicate Chinese supply chains.  Tariff barriers can discourage cheap imports but will also interrupt the inflow of funds if the output is not competitive. The idea of Make in India, to promote exports using India’s demographic dividend, should be tinkered slightly to Make in India for India by giving foreign asset managers an incentive to stay invested and become stakeholders in the country’s prosperity from merely being arbitrageurs.       

-Mohan Sule

Reality check

The perils of seasonality of products, broad-based portfolio and balancing cost-cutting with resources-raising

The Q4 performance and commentary offer glimpses of how Indian companies are viewing the road ahead, post the five-phase 75-day lockdown that began on 25 March to contain the covid-19 outbreak and started unwinding from 8 June. Most have claimed that their latest numbers would have been much superior but for the loss of the last 10 days, partially erasing the January and February growth. Hit the hardest were those whose seasonality peaked in summer as they stared at a loss stretching for the entire year and not just H1. A maker of temperature-control equipment ended in red.  A jeweller’s revenues dipped in single digit after recording a double-digit growth in the first two months. Banks and financial services providers suffered a setback as they had to make Reserve Bank of India-directed provisions in anticipation of covid-19-induced defaults.  The demand for tractors following a bountiful rabi crop stumbled.  Supply of housing-related products, whose consumption accelerates in the run-up to the southwest monsoon, slumped. Tour operators gearing up for the holiday season are reckoning a year-long break in cash inflow. An FMCG player bemoaned stockists were unable to store up on soaps at the year-end as is the usual practice. The downside of investing in businesses whose revenues are bunched over a small period rather than spread out throughout the 12 months is an important risk-aversion lesson from the current crisis.

Another outcome is the awareness of segment revenues. A portfolio catering to all price points as well as to different categories of its market has become a burden to carry for several companies rather than a winning strategy to de-risk. Generics exports contributed to pharmaceutical producers’ bumper numbers as domestic margins got bogged down by price caps. Insecticide sales of chemicals makers surged in anticipation of a normal rains but not inputs for use in industries contending with broken supply and distribution chains. The government advisory to prefer open ventilation to avoid infection propelled air-coolers.Air-conditioners requiring installation got a cool reception. Health, hygiene and nutritional brands flew off the shelves, with discretionary categories such as hair care, skin care and color cosmetics watching forlornly. Cars, two-wheelers and farm vehicles raced past trucks. Niche players riding on recovery will likely outperform their sector. Those with a broad-based basket of products are struggling to achieve optimum output due to the uneven contribution of different streams. Several are facing losses arising from depreciation in the value of inventories stocked in anticipation of India returning to growth, as captured by manufacturing and services indicators and GST collections in the first couple of months of the New Year. Another noticeable trend is the wholehearted embracing of the digital space to push volumes and profitability.Connecting offline grocers with their community through Whatsapp chats showcases how the method of attracting buyers is set for a transformation. Tie-ups are being pursued with those specializing in last-mile delivery such as food and taxi aggregators.   

When confronted with unexpected emergencies that disturb consumption patterns, the usual reaction is to hunker down by cutting on capital expenditure. Many manufacturing and services activities began partial operations in the second phase of the lockout in April and scaled up output in May. The eagerness to achieve normalcy, though at odds with the intention of rationalizing cost, is understandable as, unlike cyclical booms and busts that recur periodically, there is no clarity on the expiry date of the present medical emergency. A worry for investors should be how prepared will be enterprises obsessed with preserving cash when there is return of buoyancy. Besides, the market is finicky about how assets are deployed for growth.  High liquidity and low market value due to poor earnings visibility is a trap that is difficult to get out of. One more response, of rushing to raise funds by issuing shares or placing debt, is at once comforting and concerning. Dilution of the equity base scales down earnings per share. A portion of the operating profit has to be diverted for repayment of leverage. That there is confidence of servicing the additional burden through growth indicates optimism. Strangely, some of the companies are refraining from giving even the next quarter’s guidance because of the uncertain outlook. When existing capacities are not being utilized fully, the exercise looks building of a bridge to manage fixed costs till the tide turns.

-Mohan Sule

                                                

Heads and tails

The market rewards the bold by boosting their valuations but extracts a price from those found trying to undercut investors

                                               

Risk-taking is back. The Nifty spurted 2.5% on the day Moody’s Investor Service pulled down India to the lowest investment-grade, while maintaining a negative outlook, and the manufacturing purchasing managers’ index in May, when industries were allowed to partially resume operations, stood slightly above the reading in April, when India was in a complete lockdown. The benchmark reacted to the dismal composite and services indices by gaining 1%.  Finally, the market is looking ahead.  Rating agencies predicting chilling estimates of negative growth in the current fiscal year have conceded pick-up of buying impulse from the second half.  Going beyond projecting a full-blown recovery, they are forecasting a high single-digit sprint in the next fiscal year. The two US injections totaling US$ 2.7 trillion and the Federal Reserve’s assertion of keeping the cost of money close to zero and buying bonds till necessary have emboldened investors. The gradual opening up of economies around the globe since the beginning of the month has provided justification for taking exposure to risky assets in the emerging economies. Foreign portfolio investors net pumped in nearly Rs 21000 crore into equities in May along with the first week of June, after dumping up to Rs 69000 crore of stocks in March and April. Significantly, some Indian companies never lost hope even when infections and death toll were increasing and economic activity had come to a halt. Reliance Industries collected almost Rs 98000 crore from a bunch of quality investors in seven weeks till 7 June, a period when most of the developed world was shut. On top of it, the mega Rs 53125-crore rights issue got a commitment of 1.6 times. In the process, the stock appreciated 14% since 22 April, when the first of the big investments, Rs 43570 crore by Facebook for about 10% stake in the digital arm, came in. The market was up 9.6% in the period.

Spunky rival Bharti Airtel, too, outperformed, spiraling 31% as against the Nifty’s 25% recovery in 10 weeks from the 23 March low. The latest quarter results indicate that the worst might be over for the over-regulated and over-stretched sector. Operating profit grew over half and the margins expanded 171%. The average revenue per user jumped a quarter. Mobile data traffic increased two-thirds. Parent Bharti Telecom took the opportunity to shed 2.75% stake within four days of the peak price to mop up more than Rs 8433 crore from long-only and hedge funds and sovereign wealth funds to completely wipe out its debt. The market’s appetite, however, is restricted to easily digestible fare. Despite loose monetary policies of the US and the EU and the Reserve Bank of India reducing the lending rate 75 basis points to 4.4% on 27 March and resolving on 17 April to undertake targeted lending of Rs 1 lakh crore, Tata Motors early May had to recall its Rs 1000-crore debt issue as the participants demanded a higher coupon than the 8.8% offered by the automobile manufacturer facing a rough ride due to Brexit and slowdown in India and China.  A fortnight earlier, Fitch Ratings had downgraded its defaulter rating to B from BB-, with a negative outlook.

Hint of a buyback a week before the country went into a prolonged shutdown propelled Praj Industries 7% in a single day. The engineering services provider eventually decided to call off the proposal, blaming weak market conditions. The stock added 26% in the 11 weeks since then. The underlying message to the bio-fuel systems builder is to conserve cash, which is half of what it was a year ago, and boost valuations from operations rather than take the easy way out of extinguishing shares to bolster EPS. Another company that the market is no mood to let slip away by taking advantage of low prices is Vedanta.  The stock amassed close to 15% in roughly three weeks compared with the Nifty’s 8% increase since disclosing on 13 May the intention to delist and despite India Rating downgrading the stock to AA- from AA, with a negative outlook, on expectation of high balance-sheet leverage in FY 2021 and FY 2022. The non-promoter shareholders, owning 49% equity, look determined to force the miner to buy back the shares through reverse book-building at a much higher price than the floor of Rs 87.5, a 17% discount to the current level. The move makes sense as the Nifty Metal index is turning the corner, climbing up 19% in the period, on the expected recovery in the US and Chinese economies. The carrot and stick strategy to reward performance and punish sloth, it seems, is never going to be out of fashion.

 -Mohan Sule