Welcome to the first edition of curated weekly. Let’s keep it to the point and get straight to it.
A. Talk of the week
Liked that it was a data backed discussion. Here are my key takeaways from the same:
“Covid is not the needle that pricks the bubble, but the fuel that feeds the fire”. The broad point Ravi makes is that Covid is the catalyst that is accentuating trends already in place – rapid technology adoption, increased regulatory push (GST, Rural economy, Make in India, etc).
Last few months have shown we are in a liquidity awashed world; two pronged impact:
On growth vs value stocks:
Companies keep transitioning between growth and value stages:
Pharma, agro chem – Value to growth
Financials (lending) – Growth to value
Need a layer of growth over quality for outsized returns – look out for sectors and companies transitioning from value to growth.
Recent upmove – is there a bubble in the market?
Overall – no. Few segments – maybe. Historic comparision (captured below)
Market has squeezed valuation for a large chunk of players, assuming these won’t survive. Many of these should make a come back. Example: Till 6 months back, US generics business was presumed dead and has already generated strong alpha at the first sign of uptick in oral prices.
NASDAQ trades at P/E of 28x; which was 100 P/E during dot com bubble. FAANGs are cash rich and growing well. Can easily sustain 23x PE levels.
No rush though – Sideways market for now; revival 18-24 months away
Segments where value to growth theme is playing out?
Agro-chemicals and allied rural plays
Consecutive second good monsoon this year after 5 bad years. Good players made 15% ROCE even during the bad years
Farm Incomes expected to improve due to DBT, Agri reforms (APMC Act), improving MSP. Strong Tractor sales, Kharif sowing are cues.
With improving farm incomes, allied plays in agri value chain such as Two Wheelers, Tractors, MFIs, etc should be in watch
My take: Some stocks to “study” – Kaveri, VST Tiller, Hero MotoCorp, Suprajit Engg., Everest Industries, Arman, etc
Feels it is a multi-year journey – only small distance covered so far
Covid is accelerating shift outside China – Global clients are signing 10-20 yr contracts, financing multi-year Capex, asking companies to increase capacity to make them Tier 1/2 suppliers. Multi-year capex is leading indicator. Take cues.
Valuating re-rating already done. MCap has jumped from 20K Cr to ~1 Lakh Cr over last 5 years. 70-80K cr looks sustainable base. Current valuations are paying for next 1-1.5 years of growth.
Given growth of 20-30% and ROCE above 30%, can be a secular story – wait for dips to enter/ re-enter.
3. Pharma 2.0
From 2015 to end 2019, Pharma weight in Index declined from 7-8% to 2% and Mcap declined from 10L Cr to 3 L Cr.
Companies were only being valued for Domestic business; US generics was virtually available for free. Reasons – USFDA troubles, supply chain consolidation leading to shifting bargaining power from manufacturers to distributors, price erosion, etc
What changed in last year –
Lower ANDAs, more drug shortages, withdrawal by players = lower price erosion in US generics
USFDA has stopped being an incremental negative
2-4 years from here for US generics cycle to peak out; not going to fall off the cliff anytime soon
4. IT and Technology
India missed the bus here – still 60-70% focus on Application development, maintenance while world moved to platforms
Currently, 60-70% revenue piece is de-growing @10% and 30% digital piece is growing @30%.
Re-rating will happen when growth becomes 12-13% vs 8% now
Over 2 years, once cloud/ digital piece starts moving the needle, this space and relevant companies can see Pharma re-rating kind of move
No supply side challenges (WFH comes naturally); demand challenges
Current cost reductions will have to be passed on to US clients
My take: Dig for small listed platform plays in India – will get scarcity premium. Some names to study – Majesco, Newgen Software, etc
Data consumption trend will only increase – ride the wave
Implied savings from other aspects (travel) can be priced by providers
7% of India’s GDP has come in as FDI into Jio
ARPUs set to increase from 140-150 to 250-300 in near term
Book reco: Currently reading “How to create a mind” by Ray Kurzweil
Quotable from the talk:
“Shoot for the stars and you will land on the moon
B. Curated Reads: Investing
1. Resolving the delisting stand-off (click) by the brilliant financial journalist Aarati Krishnan
“One of the funny things about the stock market is that every time one person buys, another sells, and both think they are astute.“
IPOs attract a lot of attention and often get red-carpet welcome by starry-eyed investors. On the contrary, delisting is the less glamourous other side of the mirror when the promoters see more merit in going private as market outlook weakens.
With Covid battering investor sentiment, quite a few listed companies — Prabhat Dairy, Vedanta, Hexaware Technologies and Adani Power — have proposed to bid goodbye to the market by voluntarily delisting their shares.
Markets work on incentives. The post details what goes behind a delisting – a tug of war on delisting price between the promoters and stakeholders. Definitely not a breezy process.
When SEBI reviewed its voluntary delisting regulations in 2014, it found that of the 38 attempts from 2009 to 2014, 9 failed; 7 transactions were concluded at the floor price, while the discovered price averaged a 70% premium. In 11 offers, investors demanded two-three times the floor price, prompting promoters to shelve the idea.
Closing with this good read on a hotly debated recent delisting offer. Vendanta delisting – An open letter to Shri Anil Agarwal by Mr. Arun Goenka, an eminent expert in this space.
2. How to IPO LIC (click) by Team Finshots
From delisting, we move to the most anticipated listing of next year – LIC.
Covid has further impeded Government’s divestment plans. Also, it’s is no secret that Government finances are in a tight spot with GST collections falling 56% yoy in first 2 months of this financial year. Given this, hopes hinge on successful IPO of GoI crown jewel LIC, wherein they expect to raise between INR 70K-90K crores by divesting ~10% stake.
However, this won’t be an easy affair to attract shareholders as LIC is unlike any other listed private insurance plays.
Key difference is that while listed players have separate Participating and Non-Participating policies, 95% of profits in LIC are ploughed back to policyholders (= happy customers) and only 5% of profits is distributed to shareholders (= not so happy potential investors). Further, more than 95% of the above 5% attributable to the shareholders is distributed as dividend to the GoI, the only shareholder.
This effectively means LIC has very low Net Worth attributable to shareholders (~INR 700 crores on an asset base of INR 31 lakh crores) on and an unsustainably high Financial Leverage of 4588 times! at March 2019 (Image credits: RBSA Advisors).
The high leverage is because of the sovereign guarantee provided by GoI to the policyholders of LIC. Which leaves one with many questions:
Valuation for LIC will also be an interesting task, given non applicability of traditional measures using Insurance players. One may use various measures – here is how LIC fares on relative valuation matrix:
LIC get top spot in only 1 out of 8 parameters, while lags in 4 of 8. Understanding the nuances of LIC valuation can be a challenging exercise, so for now, we will stop here and see how this unfolds.
3. Good story on Vinati Organics (click) via YourStory
A strong wealth creator in the last 6 years (22x between 2013 and 2019), I would classify Vinati Organics as one of those stories that is transitioning from the growth to value bucket.
One common attribute of Specialty Chemical wealth creators is their specialization in one or two products (eg: Aarti Ind – Benzene, SRF, Navin – Flourine, etc).
Vinati is the global leader in niche chemicals Isobutyl Benzene (IBB) which is used in Ibuprofen and Acrylamido Methylpropane Sulfonic Acid (ATBS), commanding over 65% market share in each.
With 73% revenue from exports and negligible raw material dependency on China (inputs procured locally), it is one of the few flag bearers for the “global” Indian chemical player tag.
Key challenge – Revenue concentration by products and top clients – fortunes for Vinati depends on outlook for the product itself. ATBS, which is used mostly in Acrylic Fibre, Adhesives, Water treatment and Oil & Gas and contributes over 50% revenue for Vinati is facing sector specific growth headwinds. Management has gone slow on fresh Capex, which has put growth in question.
While management claims new products in pipeline, other existing products launched in last 3 years have only contributed to 10% to sales.
Product switching is not an easy process, so expect Vinati to consolidate between 750 to 1000 price range and investment/ sale decisions can be taken close either ends of the same for now. Let me know what you think – happy to discuss in detail in comments.
4. Impairment! Impairment!
Chances are if you are looking at Q4 results of companies, one particular item is appearing more often than ever before – Impairment. Whether these are genuinely related to the Covid pandemic or it is an opportunistic accounting jugglery needs to be understood.
As per Indian accounting standards:
Impairment loss is the amount by which the carrying amount of an asset or cash-generating unit exceeds its recoverable amount. Carrying amount: the amount at which an asset is recognised in the balance sheet after deducting accumulated depreciation and accumulated impairment losses.
Essentially, it means company overpaid for previous asset acquisitions and are now normalizing the same. If you are wondering how Impairment impacts a shareholder, in simple terms:
Most of the above stated INR 1.6 TN impairments have been on account of new ventures and overseas forays not living up to management expectations.
This interesting analysis for a popular staffing services company raises few “Quess”-tions. Worth reading and pondering:
Ambit recently published a note with companies with high recorded Goodwill (= purchase consideration paid for acquisition – sum of the net fair value of all of the assets purchased)
5. Consumer demand needs a financing mix – Auto and CV
Quite enjoyed this free wheeling interview with Mr. Srivats Ram, MD, Wheels India, one of the largest steel wheel manufacturers in the world. Relevant for one looking to get pointers on Auto and CV cycle.
Sharing some snippets that I found relevant:
With companies working at a fraction of their capacity, industrial inflation is not a major concern at the moment. When we came out of the lockdown, supply chain was very visible as an issue but this is likely to be more short term in nature. Longer term issues are really demand related.
The banking sector has been risk averse. Last year, a lot more loan applications were rejected as a result of the tougher norms and it will be even worse now. If the financing issue is not fixed, it will be harder for the passenger vehicles sector to look at reviving demand
In the last couple of years, the global firms have been looking at redistributing their sourcing. Post COVID, because the uncertainties are more, a few more companies are now looking at distributing their sourcing.
On Capex and outlook:
Investment that we make is based on business opportunities. We have invested significantly in the last two years than ever before – both into new segments and into traditional segments that [now] see over capacity. We are in weekly contact with our customers and there has been no negative feedback yet. There has been nothing that our customers have told us recently that seems to indicate that things are slowing down. And that is good news.
6. Commercial Real estate prices softening (?)
Brookfield paid 27.5% lower price for office space in same BKC tower in Mumbai compared to what Blackstone paid in 2019.
Further reading: https://mumbaimirror.indiatimes.com/mumbai/other/brookfield-sole-bidder-for-jet-office-in-bkc/articleshow/76654670.cms
As the price of diesel and petrol converges, the opex arbitrage of owning a diesel car fades away and one expects consumers to shift to Petrol variants. Will be +ive for Maruti given its portfolio of vehicles, if the trend sustains in long run.
PS: Good news – Government to pause petrol, diesel price hikes after 18-day run!
C. Curated Reads: Some amazing read from Twitter-verse
8. Two brilliant reads on “Wisdom of Crowds”
“The wisdom of crowds is defined as “the idea that large groups of people are collectively smarter than even individual experts when it comes to problem solving, decision making, innovating and predicting.”
In an investment context, this means that, when attempting to determine the fair price of a stock or bond, the aggregate estimate given by the crowd (the current market price) tends to be the best estimate of the fair price. In other words, it is very difficult for any single investor, even an expert, to be wiser than the wisdom of the crowd.“
8a. Thread by Alex Barrow talks about market behavior – determining when to follow the trend and when to disengage and go contrarian, based on advice from two legends – Peter Druckenmiller and George Soros. Not short, but well worth the time. Also makes me ponder over the crash in March and the recent “hated“ rally.
8b. The second thread by Most Borrowed Ideas dissects the maths behind why a well-rounded and diverse team almost always beats the expert. From a paper by one of few investing legends of our times MMauboussin:
9. Why India cannot move to 100% “manufacturing” of world class electronic products (mobiles/ TVs) anytime in the near future.
Indicates our strength being in cost arbitrage model vs manufacturing DNA (we did skip the manufacturing age while transitioning from agri to services) and why this is a different ball game. Hopefully, we will get there someday. For now, we will need China, so need to curb down the recent (pseudo) nationalism wave a little bit.
10. Summary of Chamath Palihapitiya latest podcast with Laura Shin
Of late, I have been enamored with everything Chamath has to say – find his views insightful, original and backed by logic. Here is discusses about the state of the market, investing philosophy and bitcoin.
That’s all for now guys – thank you for your time. See you in next edition of Curated Bi-weekly soon!
Please drop in comments on your thoughts on aspects covered. And subscribe and share if you find this relevant!