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…

Portfolio performance

OK! End of the month and lets see how portfolio has fared. Please remember this is an absolute return portfolio but still benchmarking it to give a sense of performance.

June was the worst performance in the last 9 months relatively, and fifth best in absolute terms. To put things in perspective, absolute return wise here is how they stack up –

October-11	7.5
November-11	(0.1)
December-11	(4.9)
January-12	0.1
February-12	6.6
March-12	1.9
April-12	0.9
May-12	(6.4)
June-12	0.4

So that’s 6 out of 9ms of positive outperformance and positive portfolio value since inception. So from an absolute return point – 67% hit ratio. Not bad. Relatively? Lets see

October-11	(2.4)
November-11	9.1
December-11	(0.6)
January-12	(12.3)
February-12	3.0
March-12	3.6
April-12	1.8
May-12	(0.2)
June-12	(6.8)

So uhm strike rate here a more humble 4 out of 9 – 40%. Various reasons for this –

1.       This is not an index linked portfolio

2.       Since its not index linked and its absolute INVESTMENT return portfolio, might not make sense to compare returns in such a short while

However I have given these numbers to get things in perspective about markets. Performance in June was twisted because your high beta generic names ran in the last 1 week because of various flimsy reasons – like Manmohanji raising Animal Spirits and what not!

Absolute deep value stocks like TTK Prestige, Gateway Distriparks,  Jain Irrigation (waiting for brickbats!), Treehouse Edu, Eros International have underperformed. Star of the show till date has been Power grid, consistent is not the word! Honourable mention for suitable absolute returns from TCS, LT, Dabur, HUL, ICICI and earlier BoB, ONGC, NTPC, Cipla.

So when does this turn? Well many mid caps have been taken with a 3-5 year perspective so would not comment now. For larger caps, I am very comfortable holding all of them at this juncture, a tad worried with BHEL and I know it will go nowhere for a while, but weightage wise that is minimal
Comments welcome! 

Extrapolating Economic Events to Equity Markets

The last 4 years have been unforgiving for equity investors. Markets have not been able to scale the peaks set in Dec 2007. So, typically, when we talk of equity markets giving superior inflation adjusted returns (15% as per long term average return of Sensex/Nifty), we give a time horizon of 2-3 years at least which classifies as a long term investment. So what has gone wrong? More importantly, will we ever get meaningful returns out of equity markets? Let us put a few things in perspective here. Every decade, we have a bull cycle and a bear cycle. Equity returns are non linear and hence deliver returns erratically. For instance, in the decade of 1990 to 2000, markets returned point to point 44% CAGR (fuelled by economic liberalisation) and in the Decade 2000 till date (actually 13years), markets have delivered a more humble 18% CAGR return (still best in class returns comfortably beating inflation). However, there have been very dry periods in between. Had the investor pulled out just before the rally in 2005/06? He would have lost money for the decade. The point I am making here is what is important for equity investors is not “timing” the markets but “time in” the markets.

Let us shed some light on the recent few years. 2004 onwards we had a bull market fuelled by a booming global economy which lasted nearly five years. Mar 06 onwards Inflation was the biggest issue for us and hence to prevent over heating RBI tightened rates from Mar 06 to Mar 08 from 6.5% to 9% and then when things were under control, cut from 9% to 4.75%. Again, to prevent overheating of the economy, from Mar 10 till Oct 11 RBI hiked key rates 13 times (4.75% to 8.5%). However, inflation has barely been managed.

Inflation’s unique issue recently has been that it started out as a supply side phenomenon and mutated into a demand side issue as well. What are we looking at going ahead? We will be having wage inflation for next 2 decades. 64% of WPI is manufacturing inflation so raw material effect will be rather pronounced. Food prices rose recently mainly in proteins n veggies not cereals. But food inflation will also be elevated above normal levels. For a growth economy like India, we have to learn to live with the new normal of elevated inflation for some time till we mature as an economy.

For now, commodity prices softening should help India as a whole since we are net importers but rupee effect is neutralizing all that. Rupee’s weakness understandably stems from the state of our economy and not necessarily from increasing trade deficit. So what has happened is in the last 2-3 years, corporates have been hit by twin evils of higher RM costs (thanks to massive global monetary easing) and Interest costs (RBI rate hikes & liquidity deficit).

Historic multiplier for GDP to corporate growth is 2-2.2x, so with an 8% growth, companies grew 12-15% barring 2009. Even now, with sub 7% growth they should grow 12-14%. This effectively means, barring a black swan scenario, in 4-5 years markets should double. Market multiples are driven by GDP growth and debt yields, both factors have caused de rating recently. An uptick in either could potentially better our equity gains going ahead.

So how do we get there? The approach has to change from the past, which was essentially fuelling the deficit and growth coming from consumption. Now, it should be more policy driven which would revive the extant private capex, thus creating a virtuous cycle and easing pressure on rupee and fiscal deficit. Pruning of government expenses like subsidies is a must. Regulatory road blocks which need immediate sorting would be the fuel issue for power plants, FDI in retail and aviation, implementation of GST and more astute pricing of diesel and LPG.  

So basically fiscal deficit, which government’s estimate will be 5.1% of GDP in FY13 (assuming present Rs95tn GDP growing at 8%) has to come down. My own sense is as things stand, fiscal deficit would be 5.9% of GDP, similar levels of FY12 (Rs6tn deficit on FY13 GDP of Rs101tn). So what can save us? For one, things under government control - non plan expenses. Major portion of which is subsidies, largely untouched in the budget. GOI assumes it will be Rs1.7tn in FY13, i.e. 1.7% of GDP. This has upside risks if oil under recoveries stay where they are. With total under recoveries of Rs1.1tn, where government may bear Rs0.7tn, it will be an uphill task. Fuel price hikes, reduction of subsidy (fuel, food, fertilizer) will help assail the gap.

The government is also assuming that it will undertake divestments in PSUs to the tune of Rs30bn in FY13 (aggressive in my opinion, given current market conditions). It s also assuming auction of excess spectrum and re auction of 2G to garner Rs580bn. This could be achievable if things go as per plan. Spreading tax receipts across various heads means that the GOI could garner its intended target of Rs459bn.

What is disturbing is most of the deficit will be fuelled by government borrowing which is crowding out private capex. The latter is essential for sustaining growth. Growth rates have reduced from double digits to low single digits. Addressing regulatory bottlenecks would help at this juncture more than monetary measures. We have not had serious capacity expansion in the last 4-5 years and many companies in various sectors are running at near peak capacities. This capex cycle would set the ball rolling on generating growth.

Money in equity markets is made when valuations are inexpensive. So when conviction is high and macros are good, we will not get good valuations. Key is to believe that these issues will be resolved in a reasonable time frame.  The issues enumerated above can potentially ease out in the next 2 years assuming oil prices are benign, policy measures are underway and private capex picks up.

Market multiples are attractive. We are presently trading at 12xFY13E, which is lower than our 14x median PER and the range has been 10x to 24x. Also M Cap to GDP ratio is 0.6x (India GDP $1.73tn, Nifty Mkt Cap $1tn). Historically this ratio has ranged between 0.25x to 1.1x and averaged 0.93x. So from a valuation stand point, we seem pretty well placed.

Tactically one can play rupee deficit themes in the short term through exporters like Pharma (Cipla), Auto (Bajaj), IT (HCL) , upstream oil (Cairn) and Metals (Hindalco). Medium term one can start nibbling in beta plays which are beaten down – capital goods (L&T, Crompton), private banks (ICICI Bank) and auto (Maruti, Bajaj).  Long term almost all sector leaders look attractive.