Do it yourself

Tuesday, June 20, 2017

Strategy 2H2017

"Never let the future disturb you. You will meet it, if you have to, with the same weapons of reason which today arm you against the present."

—Marcus Aurelius (Roman, 121-180)

Word for the day

Sundog (n)

A small or incomplete rainbow.

Malice towards none

PM Modi loves to surprise people. Great!

What if people surprise him?

First random thought this morning

I don't keep more than Rs500 currency in my wallet, because I fear government may scrap currency notes anytime. My faith in the examination system and meritocracy is seriously diminished. I seriously doubt any data published by the government. I am being told not to trust the story of Ramayana that my grandmother used to raise me as a good human being. I am sure my tax liabilities are going to be rise materially. To make the matter worst, Indian cricket team has lost to Pakistan. I must buy some hope.

Strategy 2H2017

As discussed in past few posts, I believe that—

(a) Indian macro environment seems stable at present, however there is not much visibility for further improvement in near future;

(b) Consumer inflation may ease further due to excessive supply. Manufacturing inflation may also stay low due to lower commodity prices, poor pricing power and stronger INR. However, rates may not fall much due to a variety of reasons, like rate trajectory in developed economies, fiscal pressures due to political reasons, falling private savings rates and capital constraints at banks. The real rates may therefore continue to be higher.

(c) There is little visibility for improvement in private investment demand. The government investment demand visibility is limited to a few sectors (mainly roads and irrigation).

(d) The consumption demand may remain stable. However, there is little visibility of any marked improvement in consumption demand.

(e) The corporate earnings may not grow at the rate of 20% CAGR over FY18-FY19. The growth is more likely to be 12-16%, depending upon (i) how fast situation normalizes post GST implementation; and (ii) how effectively NPA resolution efforts yield results. However, given cost efficiencies, better capital allocation, financial restructuring etc., the quality of corporate earnings has improved. There is therefore justification for some premium valuation over long term average of ~15x PE ratio.

(f) There is virtually no case for further re-rating of Indian equities. Post 1QFY18 results, we may in fact could see slight de-rating to 16-17x from the current 18-19x.

(g) The upside in equities in next 12-15months seems limited, insofar as the benchmark indices are concerned. The investment opportunities therefore would mostly exist beyond the benchmark indices.

My strategy for 2H2017 would be as follows:

· Continue to remain overweight in equities. Prefer long term debt.

· Focus on globally competitive businesses, preferably with significant IPR assets, market leadership and high quality of earnings.

· Underweight capital goods manufacturers.

· Prefer road and water project contractors and asset owners with stronger balance sheets.

· Prefer consumption proxies, e.g., packaging, supply chain, financing etc., versus expensive final good producers; auto OEMs.

· In financial space prefer consumer NBFCs and select MFIs.

· Continue to own large real estate developers, especially those with sizable land bank and lower dependence of pre-sales.

· Lowering overall 2017 return expectations to 12%, including 1% dividend yield.

Mid Year Review 3

Thought for the day

"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.

Friday, June 16, 2017

Mid Year Review - 2

Thought for the day

"The backbone of surprise is fusing speed with secrecy."

—Carl von Clausewitz (German, 1780-1831)

Word for the day

Prelapsarian (adj)

Characteristic of or pertaining to any innocent or carefree period, e.g., a prelapsarian youth

Malice towards none

Attributing cheaper food prices to DeMo and before time monsoon season sales to GST is a mistake, rather stupid one!

First random thought this morning

A good friend, who also happens to be a fund manager, lamented that after spending so many years in stock market, I am convinced of the massive role that "Unintended Consequence" plays. A large part of the stock market profits (or losses) in India are unintended, fringe or collateral. A handful corporates actually work to enhance shareholder value.

Unfortunately, I had nothing to say. And I do agree - in toto.

Mid Year Review - 2

So far, the year 2017 has been a satisfactory one for the investors in Indian markets.

The benchmark indices have gained over 17% YTD, while the broader markets have done even better returning over 25%.

Bond prices have been volatile, but on YTD basis, benchmark yields are lower and average return in bond funds has been 4-5% (not annualized). So not much to complain in this either. The lending rates have however fallen much more than bond yields, as the lenders have transmitted the benefit of previous rate cuts to borrowers.

INR has appreciated close to 6% YTD, versus USD.

In this period, the markets have weathered many a storms, including two Fed hikes, intense political drama (both in domestic and global spheres), slowdown in growth, disinflation, and anticipation of material business disruption due to implementation of GST, etc

Now, with each passing day, the expectations of the market participants from political establishment are diminishing. Though, the government is focusing on administrative reforms, the political compulsions are constricting the implementation. Beginning October 2017, the great election season shall commence that will last till May 2019. The government is widely expected to be populist rather than reformist.

Given the falling trajectory of inflation, poor visibility of investment demand growth due to still high real rates & poor capacity utilization across industries, challenges in job markets and poor farm realizations, the prospects of any significant acceleration in earnings growth are clouded.

Nifty currently trades at ~18x its 12months forward earnings estimates, which is a premium of ~20% to its 10yr average valuations. On the basis of FY17 earnings, Nifty trades at ~23x PE ratio. Though still some distance from bubble valuations, the probability of any spectacular return from current levels in next 12months looks low.

I have seen arguments for further rise in stock prices on the basis of price to growth (PEG) and price to book (P/BV). Some analysts are arguing for material rise in earnings in FY19. I find these arguments mostly just that "arguments"; lacking in conviction.....to continue next week

Thursday, June 15, 2017

Mid-Year review - 1

Thought for the day

"Many intelligence reports in war are contradictory; even more are false, and most are uncertain."

—Carl von Clausewitz (German, 1780-1831)

Word for the day

Humblebrag (n/v)

(n) A statement intended as a boast or brag but disguised by a humble apology, complaint, etc.

(v) To make such a disguised boast or brag, e.g., He's humblebragging about how tired he is from his world travels.

Malice towards none

Should government define an amount, it is willing to spend on bringing Vijay Mallya back home from UK?

Or no matter what we just want him back!

First random thought this morning

As per media reports, Infosys management, in its filing with SEC of USA, has highlighted it's promoters' activism as a potential risk to the company. Earlier, Wipro had highlighted president Trump's policies as a potential threat to the company.

I fail to understand, why can't these tech titans understand a basic thing - A business is only threatened when it becomes replaceable by an efficient competitor or it becomes obsolete for failing in adapting to new technologies and environment.

Rest all is, as someone said, "Covefefe".

Mid-Year review - 1

The current result season is almost over. Broadly the market commentary over results has been mixed. While there has been acceleration in earnings downgrades, the analysts seem lacking conviction in their view. One may call it the bull market fear. No one wants to swim against the tide.

The step to abolish 86% of the currency in circulation in November 2016, has been widely used as a balancing factor to explain the lower demand, both consumer and investment. I am though not able to find anything backed by adequate evidence to show that this had much impact in 4QFY17.

For record, in Q4FY17 collective PAT of Nifty companies grew 21.3%yoy driven by financials (+36.5% yoy), metals & mining (+302% yoy), petrochemicals (+62% yoy) and construction (+31% yoy).

The strong performance by metals led to a spectacular rise in the earnings of commodities companies (+70.8% yoy), while non-commodities’ earnings grew just 10.8% yoy.

EBITDA margin, however, contracted 162bp for Nifty ex-financials, impacted by sectors like auto, cement, construction, infrastructure, IT, energy, pharmaceuticals and power utilities.

The key positives from 4QFY17 results could be listed as follows:

(a) The asset quality deterioration of financial companies seems to have bottomed. The profit growth however remained skewed.

(b) Consumption growth is uneven. The urban consumption seems to have picked up, while the rural consumption remained under pressure, perhaps due to lower farm prices, higher agri input cost and financial stress.

(c) The debt servicing capabilities of beleaguered metal companies has shown improvement, led by better realization and lower interest expense.

(d) The infra companies in select sectors like road and power distribution & transmission, have shown healthy growth in order book.

(e) After remaining stagnant for three years, Nifty aggregate earnings recorded positive growth, though still in single digit.

(f) Interest rates are showing an encouraging trend.

The key negatives were:

(i) EBIDTA margins declined, showing complete lack of pricing power and rise in input costs.

(ii) IT and Pharma sector continue to face pressure both on pricing as well demand front.

(iii) Investment demand seems to be comatose for now.

Wednesday, June 14, 2017

Agenda for transformation

Thought for the day

"Principles and rules are intended to provide a thinking man with a frame of reference."

—Carl von Clausewitz (German, 1780-1831)

Word for the day

Hireling (n)

A person who works only for pay, especially in a menial or boring job, with little or no concern for the value of the work.

Malice towards none

How do we define Sino-Pak relationship?

Friendship, it is certainly not.

Slavery, may be.

Stooge, close.

First random thought this morning

It is the season when stories of children from poor and marginalized families excelling in various competitive examinations, especially IIT-JEE and UPSC Civil Services, are told in media with great fervor.

At the same time there is no dearth of horrific stories about repression of downtrodden and neglected.

Unfortunately, the popular narrative of liberal elite is limited to the latter only, thus giving an impression of total darkness and oppressive state machinery.

Agenda for transformation

The draft three year agenda released by NITI Aayog, seeks to transform all three major sectors of economy, namely agriculture, industry and services.

Insofar as the farm sector is concerned, as per the Draft, "Farmers make up nearly half of India’s workforce. Therefore, for India to flourish, its farmers and the farm economy must prosper."

The Action Agenda outlines "a strong programme for agricultural transformation. It includes numerous measures to raise farm productivity, bring remunerative prices to farmers, put farmers’ land to productive uses when they are not able to farm it themselves and improve the implementation of relief measures."

The Draft offers an ambitious agenda for empowering the rural population through improved road and digital connectivity, access to clean energy, financial inclusion and “Housing for All.”

The Draft recognizes that "Enhancing agricultural productivity requires of efficiently using inputs, introducing new technologies and shifting from low to high value commodities."

It is highlighted that higher farm productivity would require expanding the scope of irrigation to increase crop intensity, improvement in access to irrigation, enhancing the seed replacement rate and encouraging the balanced use of fertilizers.

The Draft agenda emphasizes that "Precision farming and related new technologies, that allow highly efficient farming and conserve resources, must be spread through appropriate policy interventions."

Reforming APMCs, redefining the system of support prices for crops, land reforms to make the landholdings of marginal farmers viable, and adequate social security program for farmers to deal with stress due to natural calamities etc. are some of the key suggestions.

The Draft agenda stresses that to achieve the goal of doubling farmers' income by 2022, "Conditions conducive to shift into high value commodities such as horticulture, dairying, poultry, piggery, small ruminant husbandry, fisheries and forestry need to be created."

For the industry and services sector, the agenda finds that underemployment and hence lower worker productivity is a more serious problem in India, rather than unemployment, which has remained mostly consistent between 5-8% through past many decades.

Accordingly, the Draft, emphasizes on creation of high-productivity, high wage jobs. To meet this end, it is highlighted, that focus has to be on measures necessary for the increased emergence of larger, organized-sector firms.

While recognizing steady progress in the services sector, the Agenda offers specific proposals for jumpstarting some of the key manufacturing and services sectors, including apparel, electronic goods, gems and jewellery, financial services , tourism and real estate.

I shall discuss all these proposals in some details in the coming days.

Tuesday, June 13, 2017

In search of Multibaggers

Thought for the day

"Two qualities are indispensable: first, an intellect that, even in the darkest hour, retains some glimmerings of the inner light which leads to truth; and second, the courage to follow this faint light wherever it may lead."

—Carl von Clausewitz (German, 1780-1831)

Word for the day

Athleisure (n)

A style of clothing worn as athletic apparel but also suitable for casual, everyday wear

Malice towards none

Shri Anand (Super 30) Kumar is a true Bharat Ratna, transforming life of oppressed, downtrodden and forgotten.

Salute!

First random thought this morning

It is an undisputed fact that no modern day politician wants to follow the path guided by the father of the nation Mahatma Gandhi. Most find his thoughts redundant in modern day politics and economics. His name though is invoked often for credibility purposes.

I feel the fault lies in the fact that we refuse to believe that his greatness lies in remaining an Aam Aadmi and not being incarcerated in photo frames. Not treating him a friend next door is a blunderers mistake we are making as a society.

Friday, June 9, 2017

3yr Agenda vs 5yr plan

Thought for the day

"It is not my mode of thought that has caused my misfortunes, but the mode of thought of others."

—Marquis de Sade (French, 1740-1814)

Word for the day

Serendipity (n)

1. Good fortune; luck

2. An aptitude for making desirable discoveries by accident.

Malice towards none

If it is Not Ok to identify and discriminate between rioters and miscreants by religion, why is it OK to do so on the basis of occupation?

First random thought this morning

In past two decades, I might have read a zillion reports about the looming water crisis. So much so that it has become a common belief that the next major global war will be fought for water resources.

I think water scarcity is an overrated threat, just like peak oil was.

I am confident that sooner than later, desalination will become affordable, just like long distance communication and solar energy. Besides we would have discovered agriculture & cooking methods which are less water intensive; sanitation techniques that make our washrooms water positive; and many more such things.

3yr Agenda vs 5yr plan

The incumbent government has initiated some material changes in the long established institutional framework and administrative machinery of the country. For example, the Planning Commission, that was functioning as a nodal central agency for preparing and implementing five year development plans and coordinating the development efforts with various state governments has been disbanded. With this the practice of formulating centralized 5year development plan, that included setting development & growth targets, division of execution responsibilities between the center and various states and resource allocation, has also been abandoned.

It may be noted that though set up through an executive order, over the years, the Planning Commission had become an unanimously acceptable institution for setting the policy framework and guiding and supervising the development process.

The Planning Commission has been replaced by an advisory body named the National Institution for Transforming India or NITI Aayog wef January 2015. In May 2016, the Prime Minister Office advised the NITI Aayog to "prepare a Fifteen Year Vision, Seven Year Strategy and Three Year Action Agenda documents".

NITI Aayog accordingly issued a draft Three Year Action Agenda in April 2017, that will be finalized by the governing council of the Aayog and then presented to the Prime Minister. I shall be discussing this draft agenda paper in some detail in my subsequent posts.

I want to make it absolutely clear that I am not arguing here for Planning Commission of NITI Aayog per se. I am also not commenting upon the efficacy, desirability, success, or otherwise, of the Planning Commission, that worked for over 60yrs, framed twelve 5yr plans and executed them. I am also neither judging the NITI Aayog, nor making any prophecy about its future.

I just want to highlight the conundrum that the government's decision to abolish long established institutions like the Planning Commission and UGC, presents. For example, the Planning Commission's job of making a 5yr plan more or less coincided with the tenure of an elected central government. Inarguably the development is a much longer term process and requires planning for decades in advance, breaking it into five year term, at least theoretically, allowed every governments to pursue its agenda, in accordance with the popular mandate, for its 5yr term. The system worked well without any significant discontinuity in the economy.

The point to ponder is that if NITI Aayog has to make an Agenda for the balance term of the government, and a strategy for the next term, provided PM Modi gets it, and a vision for 15years, how is it different from the Planning Commission added with Millennium Development Goals (MDG) and Vision 2020. If it was only people, the same people could have been hired at the Planning Commission. If it is control and dominance (that was perhaps not possible on a 60yr old institution), it is a major risk, the incumbent government has decided to take. For, the precedent will not go unrepeated and untried by various future governments, to the detriment of the country and its people.

Thursday, June 8, 2017

Few things are certainly different this time

Thought for the day

"Destruction, hence, like creation, is one of Nature's mandates."

—Marquis de Sade (French, 1740-1814)

Word for the day

Brinkmanship (n)

The technique or practice of maneuvering a dangerous situation to the limits of tolerance or safety in order to secure the greatest advantage, especially by creating diplomatic crises.

Malice towards none

Since we do not have any major election till October, let's bother about UK elections!

First random thought this morning

These days, 1.25bn Indians have got a variety of spokespersons.

Earlier it used be only politicians speaking for all Indians. But now days, anyone and everyone who has a social media account, thinks himself entitled and empowered to speak at behest of all Indians. So much so that people do not mind blatantly generalizing their bedroom and bathroom experiences and habits to all 1.25bn Indians.

One such spokesperson, for whom India means South Mumbai and the road from there to Sahar International Airport; and vacations in India mean annual visit to Shirdi, was heard saying "Indians are habitually unpunctual", "Indians are habitually dirty", "No Indian wants to voluntarily repay his debt", and much more.

Few things are certainly different this time

With benchmark indices ruling close to their all time high levels, valuations flirting with red lines, and broader markets showing distinct signs of accumulated froth - this is the time in a market cycle when most people volunteer to suffer from a certain degree of cognitive dissonance. "Cautious optimism" is the euphemism normally used to explain the phenomenon.

This a time when I get uncomfortable with valuations and run away stock prices, but at the same time do not want to be left behind. Just like any addict, I choose to feel guilty and but keep indulging. "This time it is certainly different" is my chant to get over the guilt. I am sure, I may not be alone in my predicament.

Having pleaded guilty, I must say that there are few things that are different in Indian markets as compared to the situation during the global financial crisis (GFC) in 2008. These differences assure me that we may not see market collapsing, the way these did in 2008 and 2009. For example, consider the following structural changes in the Indian stock markets:

(a) Risk management standards are much better now as compared to 2008. Back then more than 80% derivative positions were in individual stock futures (considered to be most risky), while less than 10% positions were Nifty options. Today the situation is exactly reverse. This means, the chances of a 5% single day fall in Nifty are just a fraction of what it used be in 2008. For record, in Nifty we had over sixty moves of 5% or more in a single day between 2007-2010. We have none since then. Even 3% single day moves have been rare in past seven years.

(b) The volatility has subsided materially. In past three years India VIX has averaged below 15, vs over 35 during 2007-09.

(c) The Indian financial markets have seen stupendous growth in institutionalization. From a mere Rs3.26trn in 2007, the asset under management of domestic mutual funds has grown to 19.26trn (30 April 2017). The number of folios in equity mutual funds schemes have almost doubled since then to 45million. Add to this the growth in PMS and Pension funds, the growth looks even more impressive.

What it essentially does is to rationalize the investor behavior. The cases of panic selling and buying get minimized. The corporates are forced to become more accountable. Today more than 25% of the companies traded on NSE hold quarterly analysts meet/investor conference call against less than 3% a decade ago.

(d) Another important change is the rationalization and stabilization of long term market returns. Notwithstanding the high returns seen in broader markets in past couple of years, long term Nifty returns have now mostly normalized closer to nominal GDP growth rates. The 5yr rolling Nifty CAGR ranged from -3% to 41% during 1995-2007. The range has moderated to -1% to 13% in past five years.

So the benchmark indices are at least running close to economic realties.

Long term Nifty returns rationalizing