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

Obsessed with the present

A forward looking market opts to discount cash handouts over reforms whose benefits are not immediately visible 

·         There are two popular assumptions about equity investing. The market knows best and the market is forward looking. Re-rating or de-rating of sectors and stocks hinge on how current events will influence the outlook. Like everything else, the covid-19 pandemic has raised doubts about these perceptions. The issue is how much the market knows and what it knows.  The Dow Jones Industrial Average index shed 4.45% on 23 March as US law makers failed to agree on a US$2.2-trillion stimulus. It would have handed out one-time amount of US$1200 per adult and US$ 500 per child for those earning up to US$75000 annually. The Federal Reserve’s assurance that it will buy unlimited treasury bonds and mortgage-backed securities to keep borrowing costs at near zero had no effect. The benchmark gained 11%, the most since 1933, the next day as a deal appeared in sight. Not only was the one-day loss recovered but the net asset value of the portfolio more than doubled. Cash in hand was assigned higher weight over no-cost funds. Liquidity can be deployed instantly. Capital takes time to ripen and harvest. The prospect of immediate consumption appeared tantalizing than demand coming after a lag.  The expected flow to service utility bills, mortgages and credit card loans and buying foodstuff held more appeal than splurging on consumer durables by availing of interest-free loan. Besides, the home confinement put in place hardly allowed any scope for discretionary spends. Going by the US market’s behavior, the lukewarm response to India’s second fiscal stimulus should not be a surprise. The Nifty slipped 3.4% the day after the last of the five tranches, annoyed with the absence of direct cash transfer.

The thrust of the first Rs 1.7-lakh-crore fiscal package on 26 March was to put money in the hands of farmers and urban and rural poor. The over Rs11-lakh-crore second set of measures turned on the liquidity tap, eased doing business and opened up the economy. The indifference was not due to dispute about their necessity but because the impact would not be visible immediately. In the pre-covid-19 era, the market might even have heralded them as taking forward the reforms process to its logical conclusion. If the forecast of good rains could propel the mainline indicator 9.5% in a fortnight, so should have the massive hike in the rural employment scheme outlay by Rs 40000 crore to Rs 1 lakh crore in the current financial year. The other numbers are equally impressive: Rs 2 lakh crore of concessional credit to PM Kisan recipients of Rs 6000 per year, emergency working capital funding of Rs 30000 crore to farmers over and above the annual allocation of Rs 90000 crore and Rs 25000-crore refinancing credit line to agriculture-focused cooperative banks and micro finance institutions. The scrapping of the Essential Commodities Act will allow farmers to bypass wholesalers to sell their produce at competitive prices. Taken together, these components should boost village income. Instead, the NSE FMCG index lost over 5%, with HUL dropping 20%, from their recent highs five weeks ago. That tractor maker Escorts and fertilizer manufacturers Coromandel, Chambal Fertilizers, Zuari Agro Chemicals and Deepak Fertilizers outperformed the market from their 23-24 March lows in the run-up to a normal southwest monsoon suggests that, when it comes to making a choice, investors prefer stocks on intravenous drip rather than benefiting from a long-drawn therapy.

The languishing bank and NBFC stocks reaffirm how temporary setbacks overwhelm a promising outlook. Dismantling the entry barriers of all industries is indeed a bold decision. The banking space is likely to have just four PSEs.  Banks will invest up to Rs 30000 crore in investment-grade paper of NBFCs. The Union government is offering full cover for lending to MSMEs and up to 20% of the first loss on loans given by banks to NBFCs. In addition, the central bank is deploying 1.50 lakh crore to buy long-term debt of NBFCs. The market, however, fretted about the potential deterioration in the asset quality of banks and NBFCs because of the increase in the minimum threshold to initiate insolvency proceedings, suspension of new bankruptcies up to one year, exclusion of covid-19-related debt from the definition of default and higher provisioning of 10% on all standard accounts permitted to defer repayment of installments. The 90-day waiting norm to declare an asset non-performing will kick in only after a moratorium of six months. The Nifty Bank and the Financial Services indices bagged the dubious distinction of under-performing even the auto and real estate indices over the past month.

-Mohan Sule