Discounting of companies is factoring in the share of products with pricing power, user stickiness and deployment of cash
14 June 2021
The worst humanitarian crisis in 100 years is how Prime Minister Narendra Modi recently described the covid-19 pandemic. Contraction in India’s GDP by 7.3% last financial year has not been seen in 40 years. For the stock market, it is the best of times. The benchmark Nifty scaled 2021’s second new high early June, doubling from its multi-year March 2020 bottom. Several companies across market capitalization not only remained profitable during the year but continued to produce record-breaking numbers in January-March 2021 after the December 2020 quarter. Even amid the bleakest period, particularly during H1, companies in India and overseas were successfully raising funds. In India, the third consecutive normal southwest monsoon, competitive and accessible money and staying relatively untouched by infections bolstered rural spending, partially compensating for the caving in of urban consumption. Money shifted from producers of essential output in the early stages of lockdowns to neglected commodities and infrastructure players as restrictions began easing. The rollout of vaccines has now rekindled hopes of the global economy eventually getting weaned away from the life-support of liquidity infusion.
In the absence of innovative tech companies, with the stature of Facebook, Apple, Netflix and Alphabet, investors in India resorted to sifting within sectors. Health and hygiene products supported the lack of interest in beauty products of FMCG players. Entry-level two-wheelers and cars were bought to avoid public transport. Drug makers with a higher share of active pharmaceutical ingredients turned star performers in search for niches. Fertilizers and insecticides makers surged as an above-average rainfall and cheap credit boosted sales. Differentiation based on demand is not new. Earlier, the backing was for those achieving scale. Higher revenues, it was believed, implied market share gain. The theory has evolved, with those commanding better margins, implying pricing power, bagging better discounting. What were informal distinctions for stock-picking even within thriving industries consolidated during the breakout and recovery from the outbreak. Companies tilted their portfolio in favor of premium products in the same category to squeeze out more realization. The strategy will pave the way to pass on increased cost of inputs as consequence of quality. If so, it will indeed be transformation of the marketplace. From pushing value for money gratification -- as amplified by sachets, beginners’ range discretionary consumer products, low-cost airlines, and budget hotels to woo ex-metro buyers -- to targeting discerning users is indeed a gamechanger. Valuations will also account for consumer engagement rather than relying primarily on the number of users. The trend has been visible for some time. The covid-19 upheaval has hastened its acceptance. The regulatory moratorium on servicing loans during the lockdown nudged investors to examine collection efficiency and composition of the assets instead of getting bewitched by the size of sanctions and disbursements. Holdings of mutual funds are getting closer scrutiny as safety supersedes risk reward. The attraction of financial institutions with a higher share of the low-cost current-account-savings-account deposits is not a secret. Also emerging is the preference for lenders servicing home mortgages and gold collaterals. Defaults are negligible when compared with borrowings against credit card limit and to finance purchase of consumer durables. A new order is emerging from the chaos.
The frenetic rush to take advantage of the cheap funds to strengthen the balance sheet by reducing debt is another outcome of the medical emergency. The discounting separating companies from peers will factor if the preparation is to face future disruptions or to cater to the pent-up demand by ramping up capacity. Cash pile cannot be hoarded. If not used for organic or inorganic opportunities, it will have to be returned to the shareholders as dividends, capitalized as bonus shares or deployed for buybacks. The equity base of many companies has ballooned from private placement of shares at moderate valuations with institutional investors. Of the many implications, the prominent is the confidence of servicing the investment due to the low bar. Second, employing the inflows to deleverage the balance sheet will allow funneling the revenue stream into operations instead of interest payment. Third, the reserves can be used to fend off unwanted suitors, attracted by the low return on assets stemming from mobility restrictions, by shrinking the outstanding capital. For investors, all the possibilities will unlock value.
--Mohan Sule
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