Tuesday, June 20, 2017

Mid Year Review 3

"Everything that exists is in a manner the seed of that which will be."
—Marcus Aurelius (Roman, 121-180)
Word for the day
Whizzo (adj)
Absolutely first-rate; superb; excellent
Malice towards none
Why overanalyze everything?
First random thought this morning
In all likelihood GST will become a reality from 1st July. This will mark a big change in Indian trade and commerce landscape.
Such big changes, especially if these happen after a considerable amount of deliberation spread over a long period of time, are mostly good for the economy at large. All apprehensions about any major disruption in the businesses might therefore be misplaced.
In my view, all pieces will fall into place within 4-6months, and businesses will move forward strength to strength. If some businesses face existential threat, GST might only be a small push not the reason for their extinction.

Mid Year Review 3

After 4QFY17 results, we have heard a number of corporate management giving positive bytes about the future outlooks, especially those from cyclical financials, capital goods sectors. Auto, consumer durable and staple producers did also sound optimistic about the growth in FY187 and FY19.
A careful analysis of the commentary shows that most of the optimism is flowing from the government promise to invest more in infrastructure & capacity building, and spend more on social sector. Corporates also seems to have built in a lower interest cost in their projections.
The commentary on global demand has remained cautious. It is therefore safe to assume that most of the growth projections rely on the pickup in domestic demand.
Though, the outlook seems to have been well accepted by the market participants, there remain some areas of doubt. For example, FY18-19 growth projections assume a stable macro environment, including achievement of fiscal and inflation targets, and a stable current account.
My feedback from industry and lenders suggests that, regardless of falling interest rates there is almost no visibility of investment demand picking up in next 12-15months, as the capacity utilization continues to remain poor and falling. The fact that underutilization of capacities is a global phenomenon, does not help either.
The recent data shows significant deterioration in private savings in India. This trend juxtaposed with rise in personal borrowings, might imply constraints on household investment and consumption growth also.
Rising reliance on government investment and consumption, along with additional resource requirement for meeting political promises (farm loan waiver) and NPA resolution (bank recapitalization, UDAY funding etc.) may challenge fiscal discipline and therefore limit easing of interest rates.
Under the circumstances, I would like to discount the corporate optimism adequately. I may therefore not work with the premise of 18-20% CAGR in earnings over FY18-19. I am however quite optimistic about the improvement in earnings efficiency (ROCE), due to better capital allocation, financial restructuring and cost efficiencies.
I am thus willing to give a premium over long term average PE multiple of ~15x.
Assuming a 16% CAGR in earnings over FY18-19 (FY17 Nifty EPS Rs420) and discounting of 18x, 12 months Nifty target comes to 10173, a mere 6% return from the current levels. Most of these return may be front ended, leaving little for 2018.
I shall therefore work with the assumption of a bad 2018 in terms of benchmark equity returns, at least 1H2018.
I shall therefore focus on niche businesses that have the capability to do well even in challenging macro environment. Being a tiny investor, I can afford to buy these business even if these are micro sized. Leveraged trade is a strict no-go zone for me, unless market corrects 15-17% from the current level.

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