Wednesday, January 8, 2020

3QFY21 - expectations modest, but may still be missed

The latest earnings season (3QFY20) shall gather steam in next few days with some large companies announcing their quarterly numbers. The market expectations this time are at great variance, insofar as the aggregate numbers are concerned. The consensus is limited to the point that financial services, especially banks, and midcaps (especially agri input) shall perform much better.

Improved credit growth, NPL recovery, lower tax and slower fresh slippages are the main factors cited for better results by the financial sector.
Good monsoon, higher MSP and prospects of a strong Rabi crop are some key factors cited for better performance of agriculture input (chemicals and fertilizers) sector. Strong pricing despite lower volumes is expected to help profitability of cement companies.
The earnings in automobile sector are expected to stay muted, as demand failed to pick up despite a good start to festival season. The estimates however vary dramatically from a sharp contraction in both revenue & profitability to a marginal improvement in revenue with decent EBIDTA and PAT growth.
Real Estate is another sector, where the consensus is expecting a sharp improvement in both revenue and profitability.
Consumption is another sector where the estimates are at sharp divergence insofar as the revenue growth is concerned. However, not much variance exists insofar as the contraction in margins is concerned.
In metals, steel sector is expected to report poor numbers with lower margins. Non-ferrous metal companies may though report a decent quarter.
Mixed results are anticipated from Pharma sector. The aggregate number may show a poor picture on EBIDTA front, however within sector there could be large divergences with some companies doing exceedingly well on the back of new launches and improved domestic sales.
Expectations of slowdown in tech spending in key markets of USA and UK appear weighing on the IT sector earnings forecasts.

In my view, the results may miss even the modest expectations and lead to further downgrad of earnings. The consumption demand outlook may particularly disappoint markets, even if some early signs of cyclical bottoming appear on the capex side.

I find the following estimates of some brokerages worth sharing with the readers.

Tuesday, January 7, 2020

There may not be enough fishes at the bottom

Couple of days ago, a friend forwarded the following chart which suggests that small cap stocks may be offering once in many year opportunity, as the value of small cap index compared to the Sensex has fallen to the point from where this index has rebounded sharply on each of the previous three occassions since 2003, when the BSE Small Cap Index was first launched.

If the strategy notes for the year 2020 published by various market participants are any indication, a significant majority of the market participants appear inclined towards this view.

Since some people have asked, I would like to share my view on this aspect. In my view, this is a purely academic exercise for three simple reasons:

1. There is no mechanism whereby an investor can directly invest in a Smallcap Index. To my knowledge there is no ETF available on the Small Cap index. It is almost impossible for an investor to buy all 60 stocks in BSE Small Cap Index or 100 Stocks in NSE Small Cap 100 Index to replicate these indices in his/her portfolio.

2. The elimination rate in small cap space is usually very high. A large number of Small Caps that performed very well during a particular market cycle, are less likely to repeat their performance in the next cycle. In fact, most "good quality" small cap stocks migrate to mid cap or large cap category in each market cycle, whereas a large number of small caps become micro cap or penny stocks.

If someone had invested in a basket of top small cap stocks in 2009 or 2014, there are almost 75% chance that stocks in that basket have either moved higher to mid or large cap or become useless losing 70-99% of their value. IN the next market cycle, wherever it happens, in likelihood we shall see a new set of "outperformers" and "multibaggers".

3. In 2001 and again 2013-14 the ratio become worse after hitting the rebound line. If one invested at the first hit, there are chances that he lost 25-30% before the rebound actually happened.

It is also pertinent to note that, while the Small cap to Sensex ratio has hit the rebound line, the Midcap to Sensex ratio is still some distance away.

What may not work in 2020 and how to separate the wheat from the chaff