The covid-19 responders

8 May 2020

Adaptability, survival instincts and resilience marked India’s economic movers and shakers during the pandemic

If the Federal Reserve was the hero for saving the global economy from the credit crunch in 2008, the Reserve Bank of India undoubtedly came into its own during the 54-day three-phase lockdown beginning 25 March. Ben Bernanke achieved legendary status by steering the US to safe harbour from the turbulence caused by home-loan defaults. The low-profile Shaktikanta Das has restored confidence in the financial system by rescuing a failed private bank and ensuring liquidity to the financial services sector at a time the economy was shut down to contain the covid-19 pandemic. The Fed chairman kept interest rates near zero and bought bonds for six years. The RBI governor has injected over Rs 8 lakh crore of liquidity since February by conducting rupee-dollar swaps,  cutting the cash reserve ratio and undertaking targeted long-term repo operations to make available credit to NBFCs, housing financiers, small businesses, farmers and mutual funds. The legacy of the heads of government is weighed against economic growth and employment during their regimes. The outcome of central banks’ interventions is determined by their success in taming inflation without dampening growth. After the initial challenge of lowering the cost of money, the test for Das will be ensuring its transmission to embolden risk-taking and, at the same time, supervising the flow of funds into productive assets by discouraging diversion to create bubbles.

Precision targeting of the problem was not confined to the central bank boss. India’s richest man, too, was aiming at the bull’s eye as he frantically went about mopping up Rs 1.04 lakh crore to meet the self-imposed end June 2020 deadline to bring down Reliance Industries’ Rs 1.61-lakh-crore net debt. Unlike his father, who did not partner with any foreigner even to build the world’s biggest petrochemicals complex, Mukesh Ambani dangled the bait of capital appreciation to entice big-ticket overseas investors for bits and pieces of his conglomerate. Facebook is putting up Rs 43570 crore for 10% equity in a venture that looks great on paper: deploying the chat platform to increase the data usage and user stickiness of Reliance Jio and expand the market of the social network. The hype boosted the stock and prompted two venture capitalists to take exposure at 12.5% premium to the price the social network paid barely 15 days earlier, propelling the digital arm’s valuation to over half of the current market cap of RIL. In the process, the Rs 1.14-lakh-crore Saudi Aramco proposed investment for 20% share in the oil and petrochemical business has been downgraded in nine months by 14.5%, assuming the digital arm subsumes the retail business. In turn, the promoter along with other shareholders will buy their entitlement of one share for every 15 held at 14% discount to the 6.5% gain in the week after the Facebook deal. The price was last seen eight months ago, when Brent oil was trading at around US$63.21 a barrel, more than double the current level. Ambani has managed the remarkable feat of stopping the slide in the stock post crash in demand for polymers. Realizing that the sun is setting on refining, he has enlisted new investors for emerging ventures on the track record of cost-efficiency and scale achieved in the old businesses.

If the discounting of RIL confounds, there was no such ambiguity for consumers during their home confinement. The clamp-down on the spread of infection reaffirmed the indispensability of local grocers, whose resourcefulness was taken for granted but hardly applauded. India’s largest FMGC marketer HUL acknowledged their importance in the Q4 results commentary. India’s most valuable company now wants to leverage its digital prowess to connect them with their community. These unorganized sector links in last-mile reach can be expected to replicate the footsteps of micro financiers, whose rapport with their borrowers facilitates ease of collections and who also become frontline receptors of changes in consumption patterns. Recognition of the important role of the small outlet, which remains functional even during medical emergencies and disasters, signals the emergence of the franchise model. The hole-in-the-wall distributor might get an upgrade and function under the umbrella of a big brand in return for captive audience as against the present practice of green-field expansion by leasing or buying space to set up yet another branch of the flagship. Along with unleashing mayhem, coronavirus has brought into the limelight the adaptability, survival instincts and resilience of India’s economic movers and shakers.

-Mohan Sule

Ring in the new

4 May 2020

Despite the defensives propping up the Nifty, the focus has to shift to emerging companies for more FPI flows

Going by the headline numbers, the Indian market is in a bear phase. The Nifty is down 25% from its historic high in January 2020. Its surge to the top was as swift as the fall, taking about four months each. Scratch the surface and the picture that emerges is not of an across-the-board bloodbath. At P/E of around 20, the mainline index is hovering near its 10-year historical performance, limiting the scope for bumper gains over two to three years. The barometer is being propped up by pharmaceutical makers, new-gen private banks, some consumption plays and multinational FMCG producers, providing a hint of the sectors that are set to reap the harvest on restoration of mobility. The rupee’s steep slide to 76.60 a US dollar is not helping tech solutions provider because of the stress in their export destinations. Nestle, Hindustan Unilever, Britannia Industries, Dr Reddy’s Laboratories and Sun Pharmaceutical Industries are the only constituents to post positive returns since a year ago. Apart from HDFC and HDFC Bank, weighing down the benchmark till recently was RIL, whose turnaround was on the back of Facebooks’ Rs 43500-crore investment in its digital arm, confirming that future valuations will be based on retail and telecom streams instead of refining margins. Whether Saudi Aramco goes ahead with the US$15-billion bill for a 20% stake remains to be seen.  Strikingly, the Nifty does not contain any real estate developer since the ejection of DLF five years ago and passing of the Real Estate Regulation and Development Act in 2016.

What the scrutiny of the index reveals is that the market is rational as it is irrational. The increased allocation to defensives during cyclical downturns, medical emergencies or the unfolding of the outcome of loose regulatory oversight bypasses their mediocre growth in favour of the cash chests. If Titan trades at 53 times the TTM EPS for its pole position, monopoly CIL commands a discounting of just 5 despite 75% return on equity. That the coal minister had to urge users to prefer the domestic supplier instead of resorting to imports perhaps offers a clue that investors take into account the intensity of competition rather than the size of the market. Entry barriers offer no solace to commodity producers. Rather supply glut and deficit determine their fate.  An example of how a huge consumption potential is not an attraction if there are chronic cash-flow problems is Power Grid Corporation of India, with a decent RoE of 20%. At the same time, the bumpy ride of Eicher Motors and Hero MotoCorp, in spite of their shareholders earning around 27% on their contribution to the equity capital, shows that being tuned to the market can be painful, when tastes change. BPCL is facing the double whammy of slumping consumption and concerns that the government stake-sale, which was to result in re-rating of the sector, might end up being a setback if undertaken at throwaway prices.

The reasonable premium on past earnings, however, turns the basket of 50 stocks richly valued on scary projections of low single-digit growth for India this year. It means three things. First, there will always be a group of counters that will blunt the slide of another bunch during a challenging phase and outperform the country’s GDP run rate. Second, disruptions are increasingly being considered temporary, with recovery aided by fiscal and monetary support from governments and central banks. Multilateral agencies are seeing a solid rebound for India and the global economy next year. Third is the shift to exchange traded funds. Money is parked in the underlying asset irrespective of performance. Many foreign portfolio investors have mandates to favour stocks in region-specific indices constructed by international institutions to facilitate ease of entry and exit. Passive funds mimic allocation as per the weight of the company or country. Opening up FPI exposure in a company to the industry’s foreign direct investment cap, instead of restricting it to 24%, is expected to increase inflows. The problem is, with promoters owning controlling stake, traditional commodity, pharmaceutical and FMCG companies are unlikely to be the attractions. Tech solutions providers recognized early in their growth stage that they had to have dispersed shareholding like US companies to gain confidence of clients in the geography. Select private banks are benefiting due to fencing of founding ownership to 15% within 15 years. Those in the best position to capture the opportunity that has opened up are in emerging areas. Digital marketplaces, credit card issuers, insurers and fintech players should start preparing their red herring draft prospectus to strike when the iron turns hot.

--Mohan Sule

Pain and gain

19 April 2020

After the sudden wealth destruction, lifting of the lockdown can boost stock valuations indiscriminately due to demand spike

The covid-19 pandemic pummeled markets worldwide in the second half of March. A decline for consecutive days as infection cases and toll numbers mounted would be punctuated with a short-lived smart recovery, reacting to fiscal and monetary injections. The immediate lesson from the severest wealth destruction in decades that has dwarfed similar eruptions including the 2000 tech bubble burst and the 2008 financial crisis is that investors have to be prepared for unforeseen disruptions and not get fixated on the seven-year bull-and-bear cycles. Black Swan events have the nasty habit of recurring instead of visiting once in a while. Sometimes it might have Chinese characteristics. Other times it might be the implosion of reckless risk-taking and lax supervision. If spread of misery does not seem to have any boundaries, pockets of prosperity, in contrast, tend to remain confined. Even as the US economy was booming, China was slowing due to trade tariff tensions and India due to stress in the financial services sector. On the other hand, no nation remained immune from the credit crunch over 11 years ago. The second learning, therefore, is the US continues to exert influence over other countries but at the same time is not dependent on any other nation’s well being for its health. The gains from the inflow of its capital are outweighed by inflation and asset bubbles in emerging economies.

The third outcome is that the markets are not amenable to reason during extreme bouts of pessimism and optimism. US equity indices were scaling new highs when unemployment was negligible and plumbed to record depths as jobless claims started climbing up from three million. These were expected to cross 10 million by the first week of April. A tight job market implies higher cost to retain and recruit employees for managing growth. Interest rates are ramped up to discourage indiscriminate borrowing and ensure funds find their way into productive projects. The impact is felt on the margins. Earnings growth slows down. Valuations should cool as any further expansion has to be through volumes and not by price hikes. Yet, such logic did not prevent the Dow Jones Industrial Average from scaling new highs. Similarly, if the market is forward looking, US stocks should begin recouping their losses as a growing pool of talent will be available for hiring at bargain salaries. In India, the Nifty came off its lifetime milestone in January 2020 because of revision in the application of dividend tax. Instead of 20% levy on the distributable net profit, the payout will be treated as income in the hands of the recipients. The globally accepted practice caused such a heartburn that the benchmarks never recovered from their glory despite economic indicators such as manufacturing index and goods and services tax collections pointed to a recovery in the offing.

India’s emphasis on making available more money at an affordable price to businesses and distributing cash and food to the weaker sections adds up to just 3.2% of the GDP as against UK’s 14%, Germany 20% and US 10%. The conservative number should provide comfort that the liquidity is focused and will not stretch government’s finances to stall investments in thrust areas. The central bank will have room to keep interest rates benign. If a few nations prefer to be outliers even while conforming to the general trend of loose money policy during an emergency is the third observation, the fourth conclusion is that the past does not always provide a roadmap. Isolating citizens and cutting off trade and travel are unique responses to a crisis that too is novel. Governments by and large preferred to have a healthy population over a buoyant economy. Eventually, the quarantine, ranging from 14 days to 40 days, will begin to produce results. The growth in new patients will slow, flatten and decline. Determining when and how to lift the lockdown will be a crucial piece in the strategy to come on tops of the crisis. A calibrated drawdown holds the key for the release of pent-up demand without overwhelming the infrastructure. Governments and companies establishing control over the comeback process will emerge winners. As India is not a homogeneous market, the path to recovery will be uneven for most companies. Many side players will spurt on a sudden spike in demand, flatten and eventually give up the gains as the situation normalizes. Several counters’ struggle to come back on track will be prolonged as they might have been in the forefront of absorbing the impact of the upheaval. Many others will prove to be duds due to the irreversible change in the way goods and services are consumed hereafter.

-Mohan Sule

The show goes on

5 April 2020

Keeping markets open signals continuity and liquidity infusion restores confidence in the nation’s currency during disruption

Doubts that a flat world have only benefits without any downsides have been permanently put to rest after the havoc caused by the covid-19 pandemic. The credit crunch nearly 12 years ago was the first signal that if global supply chains facilitated ease of doing business, they could also dispatch pain. The source of the problem might be a single country but the casualties do not remain confined to its boundaries. The cheap money made available by the Federal Reserve found its way into risky assets not only in the US but even in emerging economies. The drying up of liquidity after many American home buyers stopped servicing their mortgages threatened the survival of several smaller nations as well as companies outside the US that had felt emboldened to borrow heavily to finance their growth. When the Fed reduced the lending rate to zero and embarked on a bond-buying program after the collapse of important financial institutions, central banks in many other countries including the European Union followed. Once again monetary authorities are slashing lending rates and extending credit lines. Fiscal packages are being formulated to support businesses facing disruptions in sourcing raw materials and transporting goods as countries around the world self-isolate.

The outbreak of the severe acute respiratory syndrome in 2003 infected over 8,000 and killed 800 people in 26 nations. It did not lead to any government or central bank to come out with stimulus. Neither was travel restrictions imposed. Practising quarantine to control the earlier epidemic, however, has now become a model to contain the spread of deadly diseases. Similarly, keeping financial markets open even if stocks and bonds suffer a severe rout is expected to become a template during future calamities. Indices tumbling to multi-decade lows and bonds with higher coupon rates finding no takers even as interest rates plummet might be an alarming situation. But no policy maker would want to signal pessimism. Rather the message is of continuity. Stocks are allowed to digest the impact of the event and move on. Circuit breakers give participants time to reflect if their reaction was appropriate or harsher than merited. The duration of halt is specified. At a time when digital technology allows trading from remote locations and seamless clearing and settlement, providing investors an exit route as well as an opportunity to enter to indulge in bargain-hunting is the best course. For one, there is no clarity who should decide on a shut-down: the government, the exchange or the regulator. A consensus might be difficult to arrive on the parameters to determine when the storm has blown away. A problem of not switching off order terminals is price manipulation. Volatility is difficult to avoid when the crisis is fluid and so is the response to tackle it. Most market watchdogs select the easy option of banning sales without possession of securities, particularly when the market’s decline is relentless. The objective of imparting stability obstructs portfolio churning by offsetting losses with quality stocks at low valuations. India treaded the sensible middle path. Margins have been hiked in the cash market and so also market-wide limits for taking positions in the derivatives segment. Even such interventions are frowned by those who believe that short-selling is as legitimate an activity as taking long position.

Besides deriving comfort that markets will work even during grave threats, another significant outcome of the current turmoil is the popularity of cash transfer to the affected or lending it at practically no cost. It emboldens risk-taking at a time there is danger of paper money losing its relevance and assets such as gold gaining currency for bartering. Of course, the post apocalypse world will not be the same as it was before. Airlines never regained luster after the September 2001 terrorist attack on the US. The transformation underway in some industries due to technological obsolescence or change in taste will hasten. The result might not be what was anticipated. Cars, whether run on petrol on electricity, will not matter if work-from-home catches traction. The dot-com bubble burst at the turn of the century and stamping of expiry date on patents has knocked off the brand premium of tech support players and pharmaceutical products. Financial institutions tagged as too-big-to-fail are under increasing scrutiny to avoid a relapse of the September 2008 seizure.  Whether malls, multiplexes, retail outlets, automobiles, restaurants, hotels, fashion brands and airlines will be the casualties of social distancing will merit close attention. The winners will be digital properties connecting with consumers.

-Mohan Sule

A new template

22 March 2020

The rescue of Yes Bank has changed the risk profile of equity and debt and undermined confidence in FII presence

The State Bank of India stepping in to rescue India’s sixth largest private bank by branches and the fifth largest by assets is a continuation of as well as a break from past practices. The usual playbook is a larger and reasonably sound government-owned bank directed to scoop the rotten entity. The overriding objective is to protect the depositors. Global Trust Bank was merged with Oriental Bank of Commerce in July 2004. IDBI was told to take over United Western Bank in October 2006. In the process, the acquirer is punished for no fault. It has to hope that the addition of bad loans on its balance sheet is neutralized to some extent by the business from the expanded branch network. In the short term, the higher provisioning crimps the ability to lend. In a departure, SBI will be a strategic investor as Yes Bank will retain its identity for now. India’s largest lender will buy up to 49% equity at a premium after the capital is expanded over six times. The news propelled Yes Bank over 30% but pulled down SBI 12% in a day. With chances slim of fully writing back Rs 34000 crore of dud assets, equity infusion even up to Rs 10000 crore from the initial Rs 2450 crore has got a decent shot of earning returns. Yes Bank’s net worth has not turned negative like that of GTB in FY 2002 and United Western Bank’s capital-to-risk-weighted asset ratio end June 2006. The new-gen private bank’s net NPAs climbed up to a high of 4.35% in Q2 of FY 2019, from 0.84% a year ago, but are lower compared with UWB’s net NPAs of 5.66% end March 2006 as against the peer group figure of 1.97%. If the three-year lock-in is a downside, it will afford the struggling institution breathing space to repair the bottom line without worrying about volatility in the trading ring. The participation of SBI will stem the flight of deposits. It has emboldened ICICI Bank, HDFC, Axis Bank, Kotak Mahindra Bank IDFC First Bank and Bandhan Bank to open their cheque books.

During its merger in July 204, GTB shareholders did not get any stake in OBC. UWB investors were better placed. They were offered Rs 28 a piece, marking about 30% premium over the previous day’s closing price.  Those of Yes Bank can entertain the possibility of reaping capital appreciation in the medium term. The losers are the subscribers to the Rs 8415-crore perpetual bonds. The debt, forming part of the Tier 1 capital, has been extinguished. It made sense to get rid of the costly capital during the restructuring period. The immediate fallout will be drying up of inflows into banks looking to sell the high interest-bearing instruments without maturity. These were also a steady source of rich yields for mutual funds. The RBI’s action clashes with the objective of initiating bankruptcy proceedings, where creditors get precedence. Clarity is needed from the central bank if it wants to rewrite the traditional view of equity being more rewarding but risky than fixed income instruments. 

Besides the interest of those with an exposure, the outlook of the banking sector, too, hinges on how quickly Yes Bank shakes off the Rs 18564-crore loss incurred in the December 2019 quarter. The road to profitability will pave the way for the Union government to bring down its holding  in PSU banks to the 49% level and restore confidence in entrepreneur-driven banks that had begun to dent after some of them were pulled up by the RBI for governance issues and under-reporting of bad loans. As it is the private space has an uneven track record since being opened up. Of the 10 private sector entities given licences in 1993-94, Times Bank became the first to be merged with HDFC Bank in February 2000 by swapping shares. GTB became a source of funds for Ketan Parekh to rig stocks.  Bank of Punjab was acquired by Centurion Bank in June 2005 to form Centurion Bank of Punjab. Three years later, HDFC Bank took over Centurion Bank of Punjab. The 65% survival rate in 25 years raises the question if even the remaining eight are too many at a time nationalized banks are being merged to achieve scale. If phone banking undermined PSU banks, private banks relied on real estate, infrastructure and financial services to grow quarter after quarter. Retail investors are told to take comfort in the presence of big-ticket investors when fishing for stocks. Goldman Sachs and IFC were the shareholders of GTB when it went down. Foreign investors controlled 15% and mutual funds 5% of Yes Bank. When it comes to banks, investors will now have to scrutinize the quality of its borrowers, too.

-Mohan Sule