Random Equity THoughts

1Some random equity thoughts -

1.   Equity Risk Premium should be around 5%, Bond Yields assumed at 8.5%, so conservatively earning assumption is 13.5% (Consensus penciling in EPS growth of 16% FY15E). Assuming assumptions hold good, this should be doable. Makes case for being invested in equities.

2.       However, for the interim, the bond Yield is at 8.5%, earnings yield is 7% (5900 Nifty, 14.3xPE), still a negative yield gap (FY15 8.2%). Relative yields do matter when GDP growth is slowing and real rates are rising.  So to match the yields either inflation should be high or markets should fall (5200-5400 levels). When GDP resumes growth, earnings momentum will matter.

3.       Markets trading at 14.3x FY14E and 12.1x FY15E. ROEs still above interest rates for corporate India, breathing space which prevents immediate market collapse. Market Cap to GDP significantly deflated from 110% at peak (Median 0.75x) to 0.65x now.

4.       Sector wise, Consumers have done well whenever growth has tanked  and inflation high, like 2008 till date cycle and previously 1994-1997. Banks done best when balance sheets repaired like in 1997-2003 phase. Proper flows period and high apparent growth has seen industrials do well. Pharma etc. loose out then. So assuming things bottom out from here on and Balance sheets are repaired – H2FY15 on it could be the turn of Financials, Industrials to perform than IT/FMCG/Pharma

5.       FY14 max growth in earnings (Overall 2% growth) to come from IT – 20%+, FMCG 14%, Auto 14% and bogged down by banks (6%), Metals (-2%), Cement (-2%) etc.

6.       There are sector and stock specific issues. Financials we all know how it is, industrials specifically cap goods need balance sheets to be repaired. Timeline there can be 12ms or more. Power, Cement, Metals can be fastest off the block if macros reverse as the companies there are not over leveraged and have healthy BS. Earnings support for IT/FMCG/Pharma may prevent price destruction but these sectors can relatively underperform. Auto seems good to take off.

Hi

Been a while since I blogged! Last wrote in May. June July August have largely shed 1-2% per month on broader markets. September has bucked the trend and we saw a minor reversal though that has also been sold into towards the end. So point to point, if a investor looks at index levels, looks boringly similar at 5900 levels. However, the internals tell the story!

June and July, sectors like banking largely shed whilst FMCG and IT held up the index. However there was broad based selling in August where even family jewels like ITC HDFC Bank HDFC ICICI Bank etc. were sold into.

What caused this? The elephant in the room - Banking - was finally called out. FIIs darling for the last few years, highest sector weight in Index (30% at peak) and so on. But everyone knew the problems. The financial/banking sector will take a hit if your broader economy is screwed up. NPAs, restructuring, lower growth and so on. Finally these things caught up with banks, albeit with a different stick! RBI tightened liquidity with a series of measures to reign in a rogue Rupee which tumbled from a comfortable 55-56 levels to Rs68/$ before coming back to more acceptable 63-65 range. This hit guys like Yes Bank, Indus Ind and so on who are wholesale funded. Suddenly banks were not invincible. Everyone sold banks like they are going out of business. 30-50% fall in certain counters was not unheard of! Yes bore the brunt and so did safer banks like HDFC Bank ICICI Bank. PSUs anyways are used to that torture for some time now and they fell as per cue.

So what now? GDP print is more like below 5%, Corporate earnings flat, macro indicators bleak. Only silver lining being we may have a better CAD print thanks to lesser imports (more due to demand destruction) and reasonably buoyant exports (Thanks to IT and weakened rupee).

So how does one position a portfolio? I would still have banks in it. About a couple of good names like HDFC Bank and ICICI Bank, the former having stood the test of time and with stellar NPA and growth credentials and the latter for its risk reward perspective. I would be comfortable still holding on to my TCS/HCLs of the world. Remember TCS is at 20x forward, a shade below 22x a few years back. Net profit growth rates are similar in the 20-25% growth hemisphere! Hold it, especially when there is little else to bat for. Tech Mahindra can be a juicy addition as well post integration of Satyam and their decent traction on client mining. So hold your IT guys. FMCG I would sell others barring ITC and Dabur. Too expensive for a single digit volume growth story. Pharma seems to continue growing, like Cipla DRL SunPharma and Glenmark. Metals have been a star! THey have rallied almost 30-40% from lows. But having said that they were beaten to death by 70-80% from peaks! More of the China causal factor than anything else. I would stick with Hindalco and sell off TISCO. Hindalco seems good to grow its free cash post ending its massive capex journey. Aluminum carry trade should continue for prices to hold. Long term fundamentals also look good for it relatively seeing how Bauxite prices should sky rocket thanks to China's appetite and heavy imports. It is 100% sufficient in the good mouldy clay stuff! Hence a low Cost of Production. Utkal and Mahaan expansions should help the party. Rupee depreciation means (you sell Alumina in $ and RM is rupee based) you get your margin fillip. Add all time low valuations to the mix and you have a multi bagger! From my reco stock is up about 15% odd (after going low and rebounding back). Expect a good 40% from this stock. Other usual suspects good to hold are NTPC, Powergrid, L&T, Crompton, V Guard, Jubilant Food and Cairn.

When will there be light at end of the tunnel? I can postulate but end up being wrong! All I can say for a medium term investor is, dude, if you do not love equities....do not love holding stocks for the long term...do not bask as a part owner of a great company...DO NOT enter equities. You are better off with debt. Your risk adjusted returns on a one yr basis may be much better there considering the Earnings Yield versus Bond Yield scenario.

So why should I buy equities or rather..stay invested? Especially after a sad sad 3-4 yrs? Hold for a couple of more years. During this time you should see macros bottom (I know...I know...been saying this for a while!), earnings bottom and then a gradual GDP + corporate recovery. Capex initiation is already on with $3tn of projects being passed. The next cycle should more than compensate your 4 year dry spell. So on a 6-7 year basis, you may end up with the long term average growth on equities i.e. 15% CAGR! Now smarty pants may wonder - that is all fine. I should have just put my money in FDs and got it out at end of FY14 and invest then in mkts and make 40-50% for next two years! My take on that - Dude, I am not God nor are you. So nobody can time markets perfectly or even reasonably. So what if markets tomorrow start rising from 6000 onwards and do not stop till they reach 9000? What then? You would have just missed the mother of all bull runs! Kind of like how people missed the bus in 2004 -2007. Just relax, put only money which you do not need for the next 10 years in Equities. Sit back and enjoy the ride!

Synopsis - Then and Now!

Before we give an outlook on the Nifty going ahead, it would be suitable to set a context on how we have arrived here in the first place. Global recession notwithstanding, BRIC nation India has teetered off from a 10%+ projected GDP growth to half of that today. So how did this happen? During 2004-08 we grew above potential thanks to decent FII flows and decent global economy. Post the 2008 crisis, loose monetary policy helped offset investment and consumption demand fall. UPA2 came to power in 2009 and doled out largess in rural wages subsidies etc. thinking that equitable growth helped them win their first term. This started the downward spiral on the deficit front. Infrastructure projects got delayed due to red tape, food inflation rose. Other inflation also rose due to supply bottlenecks. We got hit further by corruption scams, rising oil prices and lack of fiscal support. Consequently RBI policy got hawkish. Private capex went down from 17% peak in FY08 to 12% in FY11 to below 10% in FY12. We got hit by rising inflation, slowing growth and weakening rupee, all against a weak global economic backdrop.

Markets reflected the aforesaid reality. They really went nowhere after attaining its peak in late 2007. Financial assets gradually got sold off by a disillusioned retail class and financial savings dropped to pre 1990 levels. Gold and Realty got these flows. In Dec 11 we really touched our recent lows and were one of the worst performing EM then thanks to our high beta nature.  India premium (to other emerging markets) also went down from 23% to 13%. Market Cap to GDP went below 0.7x. Sensex ROE declined from 24% to 16%.

Are there bright spots now? Yes, recent commodity trends indicate a better CAD print. Steady exporter performance i.e. Pharma, Agri and auto exports should help further that. Inflation has started cooling off, especially food inflation, which augurs well for companies net profit run rate and consumption demand. Private capex has started picking up and should end CY13 with a 7-8% growth. India will still invest 30-35% of its GDP, second highest after China. Mid CY12, the government, after a change in the finance minister, reasonably got its act together. It passed a few key bills like FDI in retail and insurance. Set up a Cabinet Committee on investments, postponed the GAAR bill, Invited foreign participation in domestic debt. Set the road map for GST.

The most important reform was the partial de regulation of diesel, which should help ease the subsidy burden. We expect fuel subsidies to decline from Rs1.7tn in FY13 to Rs1.2 FY14 n Rs0.9tn in FY15. Diesel accounts for 60% of total losses and can be halved to Rs480bn in FY14 from 960 and Rs180bn by FY15

Also, FII flows continue to be robust. YTD we have got in flows of $9bn, following CY12 investments worth $24bn. They account for 44% of market free float and 20% overall.  Historically, we have seen outflows of FII money only twice in recent times i.e. 1999 and 2009. So FII flows run rate might vary but their presence is largely structural unlike what media would like to term it as. We can see $8-15bn flows to India every year.

I believe Gold and Real estate holdings, if sold is $200bn flows to financial sector, this can be a big plus during these times where there is inflection between asset classes. Investors in India have been investing 2.5% of GDP in Gold in the last 3 yrs, up from 1.5% in the previous 2 decades. Gold demand was largely there due to lackluster financial investment performance as well as negative real rates in the past five years. A mere 100bps fall in gold investment to GDP means a further $15bn finding way into markets.

I expect ~6% GDP growth and 15% earnings growth in coming medium term. Also, I believe corporate run rate in earnings, though nowhere close to the boom period of 30%+ growth, is still pretty resilient ~ 15% levels.

So the next bull run is in the offing in the coming 4-8 quarters. Do retain a quality bias to portfolios as earlier iterated. FMCG, Pharma, Financials which performed well in recent 8 quarters should continue to hold fort whilst we may see incremental alpha from names in beaten down sectors like Construction/Capital Goods and the Power space. Selective mid caps should also perform well.

Amongst personal stocks being discussed in this blog since past 1-2 yrs, many have done well. Apart from front liner picks like TCS, ICICI, ITC, HUL, Dabur,Dr Reddy, Glenmark, Colgate, Maruti, there have been off beat winners like V Guard, TTK Prestige, Adani Ports.

I would say Crompton Greaves can be the next big thing. Seems to be trading at 12x one year forward and 1.5x BV, much below median levels of 16x PER and 3x book. Valuation comfort on downside. While there is still pain in the Power vertical which contributes 60% to sales and used to contribute 40% to EBIT, there seems to be buoyancy in the other two verticals i.e. consumer and industrial, which has grown 20% top line and maintained OPM in double digits for 9MFY13.

Large part of restructuring in Hungary done (it moved ops from Belgium to Hungary to save costs). The management has identified 3 areas where it can improve OPM by 400bps from present levels i.e. sourcing (Identified Shanghai as hub), selling new breed of efficient engines, going into new geographies. Also, post management change, there is a sense of cost cutting and austerity. No further inorganic acquisitions for the time being. Order book @ Rs92bn, largely short cycle orders with more of a product bias now and going ahead that would remain the strategy. Can be a good value pick from a three year perspective. May trade at 13-14x intermediately. A trading pop also seems in the offing. Not a substantial re rating, since normal business would still be a good 4-6 quarters away and there is still profitability pressure in the power segment. Just slight rerating on existing rally + initiatives taken by Co. But being patient in this stock for next 3 years can reward us value hunters. Happy hunting!

BTW, mkts are now close to its previous high. Portfolios have been doing well with a 300-400bps outperformance. FY14 has started on a good note with almost 15% absolute performance locked in for the year in the first month and a half itself. Hope this sustains and gives confidence to the retail investor to re look at the equity markets!

Those tiring cycles!

So from start of the year people were bearish after being supremely bullish at fag end of 2012. I mean, so bearish, nothing could change their view. Reasons validated their view - CAD being totally shot, sticky inflation, anemic private capex, all time low corporate earnings run rate and so on. So what changed now?

Well, for one, crude has cooled off considerably and Gold has shed ~20% in a matter of days. These are primary deficit drivers for our CAD. Hence, the print can be pretty good next time around. Inflation numbers have cooled off quite a bit, which could mean more aggressive rate cuts - favourable for banks and also the general economy.

So now the read through is going back to the same positive triggers which I have been re iterating for a while - all time low corporate earnings means a revival post some macro enablers like cooling commodities and inflation. Valuations have hit decent lows. So some down side support there. Are we through the woods? Not totally. Again sticking with a quality bias and sticking with winners here. The usual suspects like ICICI Bank, HDFC Bank, Yes, Maruti, M&M, Cairn, Cipla, DRL, Adani Ports, V Guard etc.

So 2013 comes in and out goes 2012! Wow, time flies! So if you have been reasonably following my blog, turns out some things have turned out as predicted and some have not. Corporate run rate has continued as expected whilst some counters recommended have rallied - Like Bajaj Auto, Cipla, HCL, L&T, Adani Ports etc. Some recos have not taken off like Hindalco and Cairn and some have been positive howlers like Crompton!

So how have my investments done in the last year and half? Netted about 35%. Not bad, but market also rallied 25-28% from those levels, so yeah, an alpha of about 6-7%. Partly aided by asset allocation calls and partly by good stocks (Or so I would like to believe!)

What is in store for 2013? Well for one, lets look at the good things

1. Awesome awesome liquidity! - Be it US Fed or ECB or Bank of Japan, everyone had opened their taps in 2012 and it continues. So those flows do find a way in to emerging markets like ours and in fact, 2012 has had more than a fair share of flows for India compared to historical rates (40%+ compared to 25-30%). So yes, good for equities! Also, global risk on means that people are ditching low yield bonds and moving to risk assets - Equities. All global indices have smartly rallied reflecting that. So the central banks have pushed out yields and prodded people to get into risk assets, this theme may continue to play out

2. Government Reforms - So the intent of the incumbent government is clear. Make the right noise, make parliament function and ensure some reforms go through. Hence Retail FDI being passed, Banking Regulations done, Diesel partial de regulation done, SEB reforms...all point to a government now willing to take such steps to reduce deficit and a possible downgrade to junk status for India!

3. Continuing corporate run rate - Companies have been chugging along the growth path largely, barring a few misses here and there. Augurs well for business case as well as keeping valuations around median levels.

Bad parts??
1. Continuing twin deficits - No way we can meet the deficit target set out in last year's budget. Exports not reviving. Crude poses an ugly threat and so do gold imports.
2. Pulling the plug? Some turbulence in global markets would mean that flows can evaporate from EM. Not good news for a high beta market like ours!
3. Private Capex - We need investments in infrastructure to kick off. Without that we would just be running on fumes. Also, more reforms would be needed like GST, Land Acquisition Bill etc. Lets see where this goes. Markets have run up ahead in terms of hopes.

So what does one do in such a case? Stick with quality names till macro emerges clearer. Do not get into the hype n trap of media where they talk up a sector for a month and then dump it! Be slightly ahead of the curve taking a longer term 2-3year call. Clearly would want to prune names in FMCG, Pharma, Auto which have run up steeply in 2012 and have little juice left. Would want to play cyclical stories which have stronger structures and benefit from possible future reform action - Power, Cement, Capital Goods. However, good FMCG Bank Auto names would still merit inclusion.
So ideally good stocks for 2013 could be L&T, ICICI Bank, BoB, SBI, HDFCB as all time fav, Colgate, ITC, NTPC (my fav!), Hindalco (yes I persist!), Cairn, ONGC, Cipla/Lupin. Further pushed out in blue sky 5yr time frame scenario would be slightly riskier bets like Jubilant Food, McNally Bharat, Treehouse Edu and Motherson Sumi. Nestle Adani did well and remain favorites.
What all the aforesaid stocks have in common is a good business model, reasonable industry size and scope and positioning within the industry and stellar BS/Financials. Look for these whenever investing in any stocks. Like I have said before, think about investments as how you would when analysiing a business proposal. GIve thought to future growth, how the company can scale up and manage cash flows and what is the deal (CMP) at. So looking at stocks as businesses than mere scrips would really help analysis and augment your time horizon/outlook. 

Awesome last quarter!

July-12	-0.43	-0.9	0.52
August-12	-2.70	0.6	(3.27)
September-12	5.03	8.5	(3.43)
October-12	0.16	-1.5	1.62
Novemb-12	6.16	4.6	1.54

The above are returns generated versus markets and the last column is outperformance. So you can see that OCtober and November have been pretty decent months for the portfolio. So what made it run? Unlike popular expectation that high beta has made big money in this recent stock market rally, my portfolio shows the opposite. Max alpha gainers were Power Grid (a beta of 0.5 or 0.6) with 25%+ alpha, Titan Industries with same alpha (later exited stock once it reached our fair value near 300), Cipla, Nestle etc. Only Ashok Leyland was a notable alpha pick.

So what does this denote? For the longer run, what matters is company fundamentals and business model. After all, beta is a mere co relation statistic bit, nothing to denote fundamentals. Companies who have been efficient capital allocators, have wide moats, superior return on capital employed and stellar management have gained in the last one year and more. Cipla, Nestle, Titan, HDFC, HDFC Bank, M&M are all examples of quality which has held in good stead during trying times. Moral of the story? Hold on to quality. BTW, V Guard continues to go great guns and investors would do well to hold on to the stock even though it has quadrupled from sub 100 to 400 levels. Seems to be another TTK in the making!

Quality Rules!!

The benefits of Quality 

The perfect examples of quality are HDFC & HDFC Bank. Boring businesses, rock solid. In a environment where other banks including private banks are struggling in terms of growing book and maintaining asset quality, these guys are doing both. Especially HDFC Bank, growing advances and deposits at a rapid 20% clip since forever, negligible GNPA and absent NNPA, adequate provisioning, best in class NIMs of 4% plus, these guys are amazing. In the portfolio too, understandably, they have performed well. I took in HDFC in mid Feb this year when markets were at 5500 levels, markets have delivered a YTD return absolute of minus 6% (today close Nifty 5197) whilst the stock is flat, which means I have an alpha of 6%!! Similarly, HDFC bank invested in end Feb 12 when mkts were 5400 odd levels, YTD return of markets -4% whilst the stock has given return of 13%, which in itself is awesome for a 5 month period. Alpha generation is a staggering 17% for less than half a year! Stellar. Wish my portfolio was jus these two stocks! Ah well, if wishes were horses, I would have the world’s largest stable!

In other things, though markets look boring at this juncture, the stage is being formed for upward trajectory. At least I do not see things worsening. Look at recent macro numbers – IIP good, Inflation not so bad and softening, trade deficit narrowing, Rupee strengthening and oil under check. Valuations are reasonably decent. Investors would do a favor to themselves by building a sensible and quality portfolio right now. Bulls ahoy! Happy Investing…