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