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