India

In this briefing:

1. Avanti Feeds- Q2 FY18 Results Update
2. Aarti Industries-Q2FY19 Results Update
3. Wonderla- Q2FY19 Results Update
4. Shemaroo Q2 FY 18 Results Update
5. Failure to Use the Relevant Section of the Banking Regulation Act Against Kotak Mahindra Bank

1. Avanti Feeds- Q2 FY18 Results Update

Avanti Feeds (AVNT IN)  Q2 FY19 results were significantly below our expectations. While revenues declined by 14% YoY due to low shrimp cultivation as well as low demand particularly in US , the net profit declined by 68% YoY due to increase in raw material prices in the same period. We analyze the results.

2. Aarti Industries-Q2FY19 Results Update

Aarti Industries (ARTO IN) Q2 FY19 results were beyond our expectations, as the revenues grew by 46% YoY and net profit increased by 57% YoY against our expectation of 15% and 20% YoY growth in sales and PAT. This robust result was due to improving capacity utilization, rupee depreciation and expanding contribution of higher value products.

Based on the recent developments we have revised our estimates wherein we expect sales and PAT CAGR of 18% and 22% from FY18-20e.

We analyze the results.

3. Wonderla- Q2FY19 Results Update

Wonderla Holidays (WONH IN) Q2 FY19 results were below our expectations. While revenues declined by 16% YoY, EBITDA decreased by 18% YoY in Q2 FY19. The impact was primarily from its Kerala based amusement park that got affected by the devastating flood that the state has witnessed after a gap of near 100 years. We analyze the result.

4. Shemaroo Q2 FY 18 Results Update

Shemaroo Entertainment (SHEM IN) Q2 FY19 results were in line with our expectations. While the revenues grew by 21% YoY due to a strong growth from the digital business along with a strong recovery in the traditional business post demonetization and GST impact, PAT also grew by 22% YoY in Q2 FY19. We analyze the result.

5. Failure to Use the Relevant Section of the Banking Regulation Act Against Kotak Mahindra Bank

The deadline (December 31, 2018) for Uday Kotak, the founder-CEO of Kotak Mahindra Bank (KMB), to dilute his stake to 20% has come and gone, and shareholders await the wrath of the banking regulator.

The regulator had already given an extended time line for the founders to reduce their stake, a relaxation not provided to other similar individual founders of private sector banks. When KMB realised that the regulator was no longer going to give another extension, the rebellious bank, in an unprecedented and reckless decision, took the regulator to court. The non-founder shareholders, who are in the majority, had been deprived of handsome gains which accrued to the founders by the share price increase and the extended time frame given to reduce founder shareholding, and now the bank is likely to be penalised for the founders’ not complying with the regulatory stipulation. In a benevolent gesture, the banking regulator instead of invoking the relevant section specifically dealing with wilful non-disclosure to the regulator where the punishment can be imprisonment for senior management has instead invoked a far less stringent provision where the penalties can be monetary or non-monetary on the bank.

The business media and the sell-side do not appear concerned that the majority of KMB shareholders are being negatively impacted on account of actions of the founder. But such is the corporate governance practiced in KMB. (Ironically, Uday Kotak chaired the capital market regulator committee on corporate governance; today no one is ready to criticise Kotak’s governance of his own bank.) The secular uptrend in the bank’s share price to date may now hit a regulatory headwind, and investors need to exercise caution.

In this briefing:

1. Asian Credit Monitor: 2019 Portfolio Strategy, US Rate Trajectory, China Reform Pause
2. EGM Diaries
3. Forecasting the Semiconductor Market
4. HCG Q2FY19 Results Update
5. Avanti Feeds- Q2 FY18 Results Update

1. Asian Credit Monitor: 2019 Portfolio Strategy, US Rate Trajectory, China Reform Pause

If we had to make a base observation for Asia credit markets over 2018, it was certainly caught “wrong-footed” like most of its other risky asset counterparts. The combination of a more hawkish Fed in 2018, global quantitative tightening, late-cycle economic conditions, volatility and a strong USD have all served to impact almost all the asset classes negatively. According to some asset allocators, the only asset class which returned positive in 2018 was cash, every other traditional asset class saw losses.

USD direction will further dictate the impact on overall Asian risk, in our view, with many undervalued Asian currencies following their sharp declines in 2018. One of our scenarios includes a range-bound USD in 1H19, followed by a possible reversal in 2H19 on any dovish Fed policy/US economic weakness. In this case, it has the potential to attract incremental portfolio inflows back into Asian risk. We expect a slightly tighter bias in monetary policy in most Asia ex-Japan nations which is supportive for their respective currencies.

In 2019, risk-reward dynamics have improved particularly for Asian investment grade (“IG”) where we see more limited MTM pressure. We expect a more defensive market at least in 1H19 which supports our heavier IG bias. We suspect larger investors would continue to reallocate depending on the outcomes of the China-US trade dispute and their view on US risk (arguably near its last late-cycle expansion legs). We continue to be extremely selective in Asian high yield (“HY”) which have been impacted by idiosyncratic situations including credit deterioration and rising defaults. Exogenous factors such as the potential for “fallen angel” risk (i.e. a migration from issuers on the cusp of IG, “BBB-”  into HY) as well as net portfolio outflows from HY, EM and leveraged loan funds are ongoing concerns. Despite cheaper valuations in Asian HY, we still see skewed risk-reward (with larger potential risks).

In the US, our base case expects the Fed to hike 1-2 times (quarter point each) for 2019, premised on still below-trend inflation and external factors. We think it is near the tail-end of its current tightening cycle, but we would continue to monitor the US supply-side (labour markets, employment gaps, prices) for further clues. A sustained upshot to the previous factors may have the potential to prolong the Fed’s tightening cycle.

On China’s side, we have seen a critical reversal in policy towards selective expansion/accommodation again as economic reforms instituted 3 years ago have been reprioritized. China’s difficult task to balance growth targets and restructure its economy is a perennial issue. We would also expect defaults to remain elevated domestically/internationally as a new paradigm of credit investing takes root in China.

Finally, we would like to wish our readers luck in investing and trading in the year ahead.

2. EGM Diaries

We recently attended the extraordinary general meeting (EGM) of Zydus Wellness (ZYWL IN). The primary agenda for the EGM was to approve the issue of fresh equity and raise debt to finance the acquisition of Kraft Heinz Co (KHC US) ‘s Indian subsidiary Heinz India Private Limited jointly with Cadila Healthcare (CDH IN). This will include the brands Complan (Health Food Drink), Glucon D (Glucose Powder), Nycil (Talcum Power) and Sampriti Ghee. We believe the deal is in sync with management’s vision of developing Pharma oriented consumer brands. However with recent acquisition of Glaxosmithkline Consumer Healthcare (SKB IN) by  Hindustan Unilever (HUVR IN) the competition in the health food drink market may get intense. Having said that, the largest brand Glucon D will likely continue market leadership along with Everyuth and Nycil which will be a good addition to the Zydus Portfolio. Any attempt for market share gains with Complan and Sampriti ghee will be futile and may come at a cost of margins. Based on preliminary, we expect full effect of the deal to appear on FY 2020 financials. Our preliminary estimates indicate a FY 2021 EPS of 51.68, which with a average PE multiple of 34.56 leads to a price target of INR 1809 per share implying an upside of 35% from latest close price of INR 1342. We will revisit our estimates post Q4 FY19 numbers when a much clearer picture is likely to emerge. 

3. Forecasting the Semiconductor Market

This is the time of year that Objective Analysis releases its semiconductor forecast.  This post is based upon a video posted on the WeSRCH website that explains the Objective Analysis 2019 semiconductor forecast.

Although accurate semiconductor forecasts are straightforward to produce, the consistently-accurate methodology spelled out in this Insight is rarely used.

The forecast predicts that the downturn that the industry is currently entering will be longer than most, with profits eluding chip companies until 2022.

4. HCG Q2FY19 Results Update

Healthcare Global Enterprises (HCG IN) , a leading cancer care hospital network’s (please click here for detailed report) Q2 FY19 results were inline with our expectations. Revenues grew by 16% YoY in Q2 FY19 due to strong growth from the HCG centres , EBITDA grew by only 8% in the same period due to operating losses reported by the new centers that dragged the overall profits.  We analyze the results.

5. Avanti Feeds- Q2 FY18 Results Update

Avanti Feeds (AVNT IN)  Q2 FY19 results were significantly below our expectations. While revenues declined by 14% YoY due to low shrimp cultivation as well as low demand particularly in US , the net profit declined by 68% YoY due to increase in raw material prices in the same period. We analyze the results.

In this briefing:

1. Aarti Industries-Q2FY19 Results Update
2. Wonderla- Q2FY19 Results Update
3. Shemaroo Q2 FY 18 Results Update
4. Failure to Use the Relevant Section of the Banking Regulation Act Against Kotak Mahindra Bank
5. India: Big Shortfall in Tax Collections, but Fiscal Deficit Likely to Be Contained

1. Aarti Industries-Q2FY19 Results Update

Aarti Industries (ARTO IN) Q2 FY19 results were beyond our expectations, as the revenues grew by 46% YoY and net profit increased by 57% YoY against our expectation of 15% and 20% YoY growth in sales and PAT. This robust result was due to improving capacity utilization, rupee depreciation and expanding contribution of higher value products.

Based on the recent developments we have revised our estimates wherein we expect sales and PAT CAGR of 18% and 22% from FY18-20e.

We analyze the results.

2. Wonderla- Q2FY19 Results Update

Wonderla Holidays (WONH IN) Q2 FY19 results were below our expectations. While revenues declined by 16% YoY, EBITDA decreased by 18% YoY in Q2 FY19. The impact was primarily from its Kerala based amusement park that got affected by the devastating flood that the state has witnessed after a gap of near 100 years. We analyze the result.

3. Shemaroo Q2 FY 18 Results Update

Shemaroo Entertainment (SHEM IN) Q2 FY19 results were in line with our expectations. While the revenues grew by 21% YoY due to a strong growth from the digital business along with a strong recovery in the traditional business post demonetization and GST impact, PAT also grew by 22% YoY in Q2 FY19. We analyze the result.

4. Failure to Use the Relevant Section of the Banking Regulation Act Against Kotak Mahindra Bank

The deadline (December 31, 2018) for Uday Kotak, the founder-CEO of Kotak Mahindra Bank (KMB), to dilute his stake to 20% has come and gone, and shareholders await the wrath of the banking regulator.

The regulator had already given an extended time line for the founders to reduce their stake, a relaxation not provided to other similar individual founders of private sector banks. When KMB realised that the regulator was no longer going to give another extension, the rebellious bank, in an unprecedented and reckless decision, took the regulator to court. The non-founder shareholders, who are in the majority, had been deprived of handsome gains which accrued to the founders by the share price increase and the extended time frame given to reduce founder shareholding, and now the bank is likely to be penalised for the founders’ not complying with the regulatory stipulation. In a benevolent gesture, the banking regulator instead of invoking the relevant section specifically dealing with wilful non-disclosure to the regulator where the punishment can be imprisonment for senior management has instead invoked a far less stringent provision where the penalties can be monetary or non-monetary on the bank.

The business media and the sell-side do not appear concerned that the majority of KMB shareholders are being negatively impacted on account of actions of the founder. But such is the corporate governance practiced in KMB. (Ironically, Uday Kotak chaired the capital market regulator committee on corporate governance; today no one is ready to criticise Kotak’s governance of his own bank.) The secular uptrend in the bank’s share price to date may now hit a regulatory headwind, and investors need to exercise caution.

5. India: Big Shortfall in Tax Collections, but Fiscal Deficit Likely to Be Contained

Tax revenues in India are running sharply lower than budget estimate. At current run rate, tax revenues would miss the budget estimate by almost US$19bn or 0.7% of GDP. This short-fall is almost entirely due to weaker GST revenues. Direct tax revenues are running broadly inline with the estimate suggesting the economy is doing fine. This short-fall however will not result in a material widening of the fiscal deficit. The government has been remarkably conservative in spending so far with expenditure growth running well below budget estimate. Non-tax revenues are also running ahead of full year estimate. This coupled with higher small savings collections will mean that Government borrowings will be lower than budget estimate even if the fiscal deficit is modestly higher and that will be a relief to the bond market. However, the quality of deficit is worsening with the government resorting to even more questionable routes (the PFC-REC transaction is a case in point) to achieve its disinvestment target. Additionally, it has started to resort to off-balance sheet financing with the loan to the ailing Air India from the NSSF. The numerical focus on fiscal deficit is resulting in wrong precedents being set and government finances becoming more opaque.

In this briefing:

1. Global Semiconductor Sales Fall In November 2018. This Is Not A Good Sign.
2. India Generic Drugs: Antitrust Suit Could Cost Billions
3. India: Notes from Hindi Heartland, There Are Issues but People Don’t See a Better Choice than Modi
4. Farm Loan WaiversTo Dampen Credit Growth Cycle
5. Are US Stocks A Buy Yet?

1. Global Semiconductor Sales Fall In November 2018. This Is Not A Good Sign.

The Semiconductor Industry Association (SIA) just announced that worldwide sales of semiconductors reached $41.4 billion for the month of November 2018, an increase of 9.8% YoY, but down 1.1% MoM, the first such decline since February 2018. While the decline is modest and total 2018 total semiconductor sales are on track to reach ~$470 billion for a YoY increase of 15.7%, any decline in what should be peak holiday season is not a good sign. 

Semiconductor sales historically track Wafer Fab Equipment (WFE) sales with a roughly six month time lag. North American WFE sales have been declining each month for the past six months meaning that this latest semiconductor MoM sales decline is right on schedule.  

Leveraging a decade’s worth of historical data, we analyse two key questions that are likely on every investors mind. Firstly,for how long should we expect semiconductor sales to continue their decline. Secondly, how steep should we expect that decline to be?    

2. India Generic Drugs: Antitrust Suit Could Cost Billions

This Insight builds on our previous Insight, India Generic Drugs: US Antitrust Inquiry Widens by discussing estimated potential liabilities and details contained in court filings. Public comments by one of the plaintiffs (47 states) suggest the defendants’ aggregate liability could exceed US$6 billion, the largest previous settlement on record. There is not enough information to apportion potential liability by company, but some companies are better-positioned to bear the cost of a settlement than others. The process could drag on for an undetermined period of time (which helps the defendants). At the same time, the overhang will keep a lid on generic drug prices in the US market. 

Among Indian generic companies, Dr. Reddy’S Laboratories (DRRD IN), Aurobindo Pharma (ARBP IN),Cadila Healthcare (CDH IN), and Glenmark Pharmaceuticals (GNP IN) have the highest risk based on their market caps and exposure to the US market.       

3. India: Notes from Hindi Heartland, There Are Issues but People Don’t See a Better Choice than Modi

We have spent more than ten days in Uttar Pradesh in the second half of December 2018 and tried to assess the chances for BJP and how it could perform in 2019 Lok Sabha elections. Of course the number of seats which each party could win depends more on coalitions, the vote share will remain important nonetheless. We were trying to understand the voting preference of people and the political choices they will be making next year.

First, the good news for BJP is that Prime Minister continues to enjoy almost similar level of popularity as 2014 (the previous Lok Sabha elections) and 2017 (previous Assembly elections in the state). There is also perception that BJP Governments are in general much less corrupt than administration provided by other political parties including Congress. BJP is by far the No. 1 political entity in the state because of Modi’s leadership.

But there is also important bad news, a) the level of satisfaction with state Govt is much lower, b) issues such as cow protection have become nuisance for many people, farmers for example, c) there is a perception that BJP’s simple majority at the Centre and 3/4th majority in state made accountability more difficult and that was the reason governance also suffered in a big way, and, d) people also think that BJP’s elected representatives are not qualitatively different vs. other parties.

4. Farm Loan WaiversTo Dampen Credit Growth Cycle

The NPA growth cycle affects credit growth cycle negatively. The recent farm waivers announced by many state governments and the speculations of a nationwide farm loan waiver by the Central government do not augur well for the banks’ credit space in India.

5. Are US Stocks A Buy Yet?

• 5%-like rallies on Wall Street are signs of a bear market not a bull market
• Bull markets require strong liquidity and low risk appetite, neither yet apply
• Risk appetite readings at minus 12.6 are still above the minus 40 criterion for an upturn
• Recent large fall in risk appetite consistent with upcoming economic recession

In this briefing:

1. Monthly Geopolitical Comment: Redrafting of Global Map of Political Alliances to Continue in 2019
2. Direct Income Transfers Likely Soon; Universal Basic Income Possible By 2024 Funded by RBI Reserves
3. Larsen & Toubro (LT IN): Slowdown in New Orders Is Risk for 3Q, Markets Can’t Ignore It for Long
4. Prabhat Dairy Ltd – Update: Revenues and Margins Continues to Increase in Line with Our Expectations
5. Alkem Laboratories – En Route to Recovery, Valuations Attractive

1. Monthly Geopolitical Comment: Redrafting of Global Map of Political Alliances to Continue in 2019

2. Direct Income Transfers Likely Soon; Universal Basic Income Possible By 2024 Funded by RBI Reserves

Direct income transfers to farmers are likely to become reality as competitive loan waivers are fast becoming a norm than an exception and every party is offering a larger waiver. 

Direct income transfers have been quite successful in the South Indian state of Telangana with KCR promising one at the national level if the Federal front (that he is proposing) is voted to power in the general elections. 

Cost of each of the measures (from loan waivers to universal basic income for all Indians) is between 0.7% to 2.7% of GDP with Universal Basic Income  (Rs 7620/individual for 75% of Indians) costing the highest. 

Even as initial fiscal costs are alarming, a gradual scale up (like in the Rural Employment Guarantee Scheme) and transfer of reserves from RBI in tranches could mitigate some fiscal impact. We expect the expert committee of the govt and the RBI to identify transferable reserves between Rs 1.0trn – 3.0trn. 

Overall, the freebies to Rural India will certainly power the consumption story strongly in 2019 with products sold in rural areas like FMCG, tractors and motorcycles expected to gain.

3. Larsen & Toubro (LT IN): Slowdown in New Orders Is Risk for 3Q, Markets Can’t Ignore It for Long

Larsen & Toubro (LT IN) has reported the new orders worth only Rs95 bn after 2Q FY19 results (reported on 31st October 2018). This is much lower run rate as compared to 2Q FY19 (Rs419 bn) or 1H FY19 (Rs781 bn). All these orders by Larsen & Toubro (LT IN) have been received from construction segment where margins are relatively poor e.g. the construction and infrastructure segment of Larsen & Toubro (LT IN) in 2H FY19 has reported 6.8% EBITDA margin, much lower than 11.8% for the company on an overall basis.

Unless new orders pick up in next few weeks, there is a strong likelihood that there could be a negative surprise in 3Q results on order inflow for Larsen & Toubro (LT IN) . This is despite the fact that overall number reported for a quarter for order inflow is a bit higher than the sum of individual orders announced and reported by the company. While the market has not noticed decline in new orders so far and may have been still hopeful about a recovery in order wins, it is highly unlikely that this will continue to get ignored by investors if the trend doesn’t change and get better in next couple of weeks.

4. Prabhat Dairy Ltd – Update: Revenues and Margins Continues to Increase in Line with Our Expectations

Prabhat Dairy Ltd’s quarterly result is in line with our expectation. In Q2 FY19, the company registered a growth of 8.53% YoY, EBITDA margin was 9.4% improving by 119 bps since the same period last year, EBITDA grew by 24.2% YOY; the profit margin was at 2.95%  improving by 60 bps YoY, Net Income grew by 35.86% YOY.  For more details about the company, please refer to our initiation report  Prabhat Dairy Ltd – An Emerging Star in the Indian Milky Way. B2B business contributed to 70% of revenue and the remaining 30% was driven by B2C business. Value Added Products contributed to 25% of revenue in Q2FY19.

The stock is trading at 16.3x its TTM EPS, 13.8x its FY19F EPS. Margins have improved over the past quarters due to lower cost of raw materials, we expect raw materials to continue to be lower than their historic average in short term. Lower cost of raw material along with the improving contribution from B2C will lead to higher margins in medium to long term. The company also wants to increase its B2C contribution aggressively from the current 30% to 50% by 2020.

We will monitor the stock closely to firm up our views further, albeit we remain positive on the long-term prospects of the company.

5. Alkem Laboratories – En Route to Recovery, Valuations Attractive

Alkem Laboratories (ALKEM IN) produces branded generics, generic drugs, active pharmaceutical ingredients and neutraceuticals, which it markets in India and over 50 countries internationally. With a portfolio of over 700 brands covering all the major therapeutic segments and a pan-India sales and distribution network, Alkem has been ranked amongst the top ten pharmaceutical companies in India by sales for the past 13 years.

We are optimistic about Alkem because-

• Alkem continues to grow significantly ahead of the segment growth rate of ~16% in the chronic therapy areas of Cardiac, Antidiabetic, Neuro / Central nervous system (CNS) and Derma. Alkem continues grow in the acute therapy areas of Anti-infective, Gastro-intestinal, Pain/ Analgesic and Vitamins / Minerals /Nutrients.

• We expect India revenues to grow at CAGR 13% (FY18-21E) to Rs 64,687 mn in FY21E from Rs 44,900 mn in FY18. We expect US revenues to grow at CAGR 31% (FY18-21E) to Rs 30,438 mn from Rs 13,667 mn in FY18 and other international business revenues to grow at CAGR 11% (FY18-21E) to Rs 6,443 mn in FY21E from Rs 4,670 mn in FY18.

• We expect EBITDA to grow at CAGR 21% (FY18-21E) to Rs 18,638 mn in FY21E from Rs 10,566 mn in FY18 and EBITDA margins to expand by ~ 190 bps to 18.4% in FY21E from 16.5% in FY18. We expect PAT to grow at CAGR 27% (FY18-21E) to Rs. 12,979 mn in FY21E from Rs 6,289 mn in FY18 and we expect PAT margins to expand by ~ 300 bps to 12.8% in FY21E from 9.8% in FY18.

• We expect RoE to expand by ~530 bps to 19.0% in FY21E from 13.7% in FY18 and RoCE to expand by ~390 bps to 21.1% in FY21E from 17.2% in FY18

We initiate coverage on Alkem with fair value of Rs. 2,260/- representing a potential upside of 21% in the next 12 months. We arrived at the fair value by applying 22x multiple to September 20E EPS of Rs 102. Currently, the stock trades at 21x and 17x its earnings estimates for FY20E and FY21E respectively. After a very volatile 2018, we believe Alkem share price may have smooth upwards move in 2019 driven by strong PAT growth in the next 3 quarters.  

In this briefing:

1. Swaraj Engines: Positive Outlook But Growth Is Slowing and Valuation Is Rich
2. Changing Lanes

1. Swaraj Engines: Positive Outlook But Growth Is Slowing and Valuation Is Rich

Swaraj Engines (SWE IN) (SEL)is primarily manufacturing diesel engines for fitment into Swaraj tractors manufactured by Mahindra & Mahindra Ltd. (M&M). The Company is also supplying engine components to SML Isuzu Ltd used in the assembly of commercial vehicle engines. SEL was started as a joint venture between Punjab Tractor Ltd (now acquired by M&M Ltd) and Kirloskar Oil Engines Ltd. M&M holds 33.3% stake in SEL and is its key client.  

We are positive about the business because:

• SEL’s growth is correlated with M&M’s tractor business growth. SEL supplies engines to the Swaraj division of M&M. M&M expects tractor growth to be around 12% YoY in FY19E. We forecast SEL’s tractor engine volumes will grow at a CAGR of 12% for FY18-21E.
• The growth of the company is dependent on the monsoon and rural sentiments. We expect the profitability to improve with normal rainfall and government initiatives towards the rural sector. We expect the revenue/ EBITDA/ PAT CAGR for FY18-21E to be 14%/ 15%/ 14% respectively.
• SEL is debt free and a cash generating company. It has a healthy and stable ROCE and ROE. SEL has increased its capacity from 75,000 engines in FY16 to 120,000 engines in FY18. We expect the capacity utilisation to reach 97% by FY20E from 90% in 1HFY19. SEL funds its capex through internal accruals. We forecast a capex of Rs 600 mn for FY19E to FY21E considering the requirement of the additional capacity, R&D and testing costs for new and higher HP engines & for upgradation of engines according to the TREM IV emission norms for >50 HP engines.

We initiate coverage on SEL with a fair value objective of Rs 1,655/- over the next 12 months. This represents a potential upside of 15% from the closing price of Rs 1,435/- (as on 26-12-2018). We arrive at the fair value by applying PE multiple of 18x to EPS of Rs 87/- to the year ending December-20E and add cash of Rs 82/- per share. While the business outlook is good, we think the upside in the share price is limited due to rich valuation.

2. Changing Lanes

The hyper-competitive Indian payments industry is changing. New regulations are increasing the cost operations, NPCI (National Payments Corporation of India) & Reserve Bank of India (RBI) are breaking all barriers to entry enabling a level playing field that ensures no competitive moats exist. Although there are volumes, profitability remains a distant dream and likely to remain so making Indian payments a bad business to be invested in.

In this briefing:

1. Changing Lanes
2. India: 2018 Is Watershed Year for Renewables with Decline in New Capacity Additions, What Is Next?
3. Autonomous Driving. Waymo Leading The Charge With Ten Million Miles Driven And Counting

1. Changing Lanes

The hyper-competitive Indian payments industry is changing. New regulations are increasing the cost operations, NPCI (National Payments Corporation of India) & Reserve Bank of India (RBI) are breaking all barriers to entry enabling a level playing field that ensures no competitive moats exist. Although there are volumes, profitability remains a distant dream and likely to remain so making Indian payments a bad business to be invested in.

2. India: 2018 Is Watershed Year for Renewables with Decline in New Capacity Additions, What Is Next?

2018 is a watershed year for renewable energy in India, a) the growth has turned negative in capacity additions after several years of huge capacity addition increase in Solar, b) the wind power generation capacity additions is depressed once again after a very poor 2017. The apparent reason is significant delays in commissioning of projects because of execution challenges but there are structural issues as well and this means that there is not much certainty on how things will evolve in future.

The current financial year has seen a big change in general sentiment towards renewables in India and there were instances of cancelled bids and project disputes. More importantly, we think there are important changes we will see in 2019, a) the tariffs may not be increasing in bids but the level on decline we had observed in 2017 is now firmly in the past and this trend will get stronger and tariff bids will be stabilizing, b) Financing will be a major challenge and banks are not interested in power sector with not many alternatives available.

After Indian renewable energy space generated massive interest among power companies as developers and also from investors, we in all likelihood will see a more rational approach in future. It is not certain but hopefully, Govt expectation of continuously declining tariffs will become more reasonable. After a serious decline of more than 80% in solar tariffs over ten years, Govt expectation on per unit prices is continuously getting lower which  is an unrealistic assumption because of change in cost dynamics.

3. Autonomous Driving. Waymo Leading The Charge With Ten Million Miles Driven And Counting

Waymo CEO John Krafcik made some bold decisions after taking the helm at Alphabet‘s self-driving project in September 2015. Chief among them was the fact that the company abandon its plans for Level 3 automated driving and focus exclusively on levels 4 & 5. Furthermore, he decreed that Waymo would no longer manufacture its own vehicles but would instead integrate their technology into those of other automakers. Three years later, those decisions would appear to be finally paying off.

On October 10 2018, Waymo reached a significant milestone having completed 10 million self-driving miles across 25 cities in the US. While their first million self-driving miles took 18 months to complete, Waymo now clocks up over a million self-driving miles per month.  The company also recently announced the launch of its robo taxi service in Phoenix, Arizona and looks set to quickly follow suit in California. Plans to extend its self-driving technology beyond robotaxis, most notably for trucks and last-mile transportation solutions are also in the works. Furthermore, the company has begun laying down a framework of innovative B2B revenue models which should help accelerate the speed with which they can eventually monetize their technology.

It hasn’t been smooth sailing all the way for Waymo however. Earlier this year, the company was derided for the driving style of its autonomous vehicles and faced the criticism that its driverless cars continue to have safety drivers. There was also an embarrassing incident where one of those very safety drivers caused the self-driving car he was monitoring to hit a motorcyclist when he attempted to take control of the vehicle. According to Waymo’s own analysis of the vehicle log files, the accident would not have happened had he not intervened. 

With ten million self-driving miles under their belt and a thoughtful, strategic approach to monetizing their technology beginning to emerge, Waymo remains firmly ahead of their peers in leading the autonomous driving charge.  

In this briefing:

1. EGM Diaries
2. Forecasting the Semiconductor Market
3. HCG Q2FY19 Results Update
4. Avanti Feeds- Q2 FY18 Results Update
5. Aarti Industries-Q2FY19 Results Update

1. EGM Diaries

We recently attended the extraordinary general meeting (EGM) of Zydus Wellness (ZYWL IN). The primary agenda for the EGM was to approve the issue of fresh equity and raise debt to finance the acquisition of Kraft Heinz Co (KHC US) ‘s Indian subsidiary Heinz India Private Limited jointly with Cadila Healthcare (CDH IN). This will include the brands Complan (Health Food Drink), Glucon D (Glucose Powder), Nycil (Talcum Power) and Sampriti Ghee. We believe the deal is in sync with management’s vision of developing Pharma oriented consumer brands. However with recent acquisition of Glaxosmithkline Consumer Healthcare (SKB IN) by  Hindustan Unilever (HUVR IN) the competition in the health food drink market may get intense. Having said that, the largest brand Glucon D will likely continue market leadership along with Everyuth and Nycil which will be a good addition to the Zydus Portfolio. Any attempt for market share gains with Complan and Sampriti ghee will be futile and may come at a cost of margins. Based on preliminary, we expect full effect of the deal to appear on FY 2020 financials. Our preliminary estimates indicate a FY 2021 EPS of 51.68, which with a average PE multiple of 34.56 leads to a price target of INR 1809 per share implying an upside of 35% from latest close price of INR 1342. We will revisit our estimates post Q4 FY19 numbers when a much clearer picture is likely to emerge. 

2. Forecasting the Semiconductor Market

This is the time of year that Objective Analysis releases its semiconductor forecast.  This post is based upon a video posted on the WeSRCH website that explains the Objective Analysis 2019 semiconductor forecast.

Although accurate semiconductor forecasts are straightforward to produce, the consistently-accurate methodology spelled out in this Insight is rarely used.

The forecast predicts that the downturn that the industry is currently entering will be longer than most, with profits eluding chip companies until 2022.

3. HCG Q2FY19 Results Update

Healthcare Global Enterprises (HCG IN) , a leading cancer care hospital network’s (please click here for detailed report) Q2 FY19 results were inline with our expectations. Revenues grew by 16% YoY in Q2 FY19 due to strong growth from the HCG centres , EBITDA grew by only 8% in the same period due to operating losses reported by the new centers that dragged the overall profits.  We analyze the results.

4. Avanti Feeds- Q2 FY18 Results Update

Avanti Feeds (AVNT IN)  Q2 FY19 results were significantly below our expectations. While revenues declined by 14% YoY due to low shrimp cultivation as well as low demand particularly in US , the net profit declined by 68% YoY due to increase in raw material prices in the same period. We analyze the results.

5. Aarti Industries-Q2FY19 Results Update

Aarti Industries (ARTO IN) Q2 FY19 results were beyond our expectations, as the revenues grew by 46% YoY and net profit increased by 57% YoY against our expectation of 15% and 20% YoY growth in sales and PAT. This robust result was due to improving capacity utilization, rupee depreciation and expanding contribution of higher value products.

Based on the recent developments we have revised our estimates wherein we expect sales and PAT CAGR of 18% and 22% from FY18-20e.

We analyze the results.

In this briefing:

1. Wonderla- Q2FY19 Results Update
2. Shemaroo Q2 FY 18 Results Update
3. Failure to Use the Relevant Section of the Banking Regulation Act Against Kotak Mahindra Bank
4. India: Big Shortfall in Tax Collections, but Fiscal Deficit Likely to Be Contained
5. Global Semiconductor Sales Fall In November 2018. This Is Not A Good Sign.

1. Wonderla- Q2FY19 Results Update

Wonderla Holidays (WONH IN) Q2 FY19 results were below our expectations. While revenues declined by 16% YoY, EBITDA decreased by 18% YoY in Q2 FY19. The impact was primarily from its Kerala based amusement park that got affected by the devastating flood that the state has witnessed after a gap of near 100 years. We analyze the result.

2. Shemaroo Q2 FY 18 Results Update

Shemaroo Entertainment (SHEM IN) Q2 FY19 results were in line with our expectations. While the revenues grew by 21% YoY due to a strong growth from the digital business along with a strong recovery in the traditional business post demonetization and GST impact, PAT also grew by 22% YoY in Q2 FY19. We analyze the result.

3. Failure to Use the Relevant Section of the Banking Regulation Act Against Kotak Mahindra Bank

The deadline (December 31, 2018) for Uday Kotak, the founder-CEO of Kotak Mahindra Bank (KMB), to dilute his stake to 20% has come and gone, and shareholders await the wrath of the banking regulator.

The regulator had already given an extended time line for the founders to reduce their stake, a relaxation not provided to other similar individual founders of private sector banks. When KMB realised that the regulator was no longer going to give another extension, the rebellious bank, in an unprecedented and reckless decision, took the regulator to court. The non-founder shareholders, who are in the majority, had been deprived of handsome gains which accrued to the founders by the share price increase and the extended time frame given to reduce founder shareholding, and now the bank is likely to be penalised for the founders’ not complying with the regulatory stipulation. In a benevolent gesture, the banking regulator instead of invoking the relevant section specifically dealing with wilful non-disclosure to the regulator where the punishment can be imprisonment for senior management has instead invoked a far less stringent provision where the penalties can be monetary or non-monetary on the bank.

The business media and the sell-side do not appear concerned that the majority of KMB shareholders are being negatively impacted on account of actions of the founder. But such is the corporate governance practiced in KMB. (Ironically, Uday Kotak chaired the capital market regulator committee on corporate governance; today no one is ready to criticise Kotak’s governance of his own bank.) The secular uptrend in the bank’s share price to date may now hit a regulatory headwind, and investors need to exercise caution.

4. India: Big Shortfall in Tax Collections, but Fiscal Deficit Likely to Be Contained

Tax revenues in India are running sharply lower than budget estimate. At current run rate, tax revenues would miss the budget estimate by almost US$19bn or 0.7% of GDP. This short-fall is almost entirely due to weaker GST revenues. Direct tax revenues are running broadly inline with the estimate suggesting the economy is doing fine. This short-fall however will not result in a material widening of the fiscal deficit. The government has been remarkably conservative in spending so far with expenditure growth running well below budget estimate. Non-tax revenues are also running ahead of full year estimate. This coupled with higher small savings collections will mean that Government borrowings will be lower than budget estimate even if the fiscal deficit is modestly higher and that will be a relief to the bond market. However, the quality of deficit is worsening with the government resorting to even more questionable routes (the PFC-REC transaction is a case in point) to achieve its disinvestment target. Additionally, it has started to resort to off-balance sheet financing with the loan to the ailing Air India from the NSSF. The numerical focus on fiscal deficit is resulting in wrong precedents being set and government finances becoming more opaque.

5. Global Semiconductor Sales Fall In November 2018. This Is Not A Good Sign.

The Semiconductor Industry Association (SIA) just announced that worldwide sales of semiconductors reached $41.4 billion for the month of November 2018, an increase of 9.8% YoY, but down 1.1% MoM, the first such decline since February 2018. While the decline is modest and total 2018 total semiconductor sales are on track to reach ~$470 billion for a YoY increase of 15.7%, any decline in what should be peak holiday season is not a good sign. 

Semiconductor sales historically track Wafer Fab Equipment (WFE) sales with a roughly six month time lag. North American WFE sales have been declining each month for the past six months meaning that this latest semiconductor MoM sales decline is right on schedule.  

Leveraging a decade’s worth of historical data, we analyse two key questions that are likely on every investors mind. Firstly,for how long should we expect semiconductor sales to continue their decline. Secondly, how steep should we expect that decline to be?    

In this briefing:

1. India: Notes from Hindi Heartland, There Are Issues but People Don’t See a Better Choice than Modi
2. Farm Loan WaiversTo Dampen Credit Growth Cycle
3. Are US Stocks A Buy Yet?
4. Monthly Geopolitical Comment: Redrafting of Global Map of Political Alliances to Continue in 2019
5. Direct Income Transfers Likely Soon; Universal Basic Income Possible By 2024 Funded by RBI Reserves

1. India: Notes from Hindi Heartland, There Are Issues but People Don’t See a Better Choice than Modi

We have spent more than ten days in Uttar Pradesh in the second half of December 2018 and tried to assess the chances for BJP and how it could perform in 2019 Lok Sabha elections. Of course the number of seats which each party could win depends more on coalitions, the vote share will remain important nonetheless. We were trying to understand the voting preference of people and the political choices they will be making next year.

First, the good news for BJP is that Prime Minister continues to enjoy almost similar level of popularity as 2014 (the previous Lok Sabha elections) and 2017 (previous Assembly elections in the state). There is also perception that BJP Governments are in general much less corrupt than administration provided by other political parties including Congress. BJP is by far the No. 1 political entity in the state because of Modi’s leadership.

But there is also important bad news, a) the level of satisfaction with state Govt is much lower, b) issues such as cow protection have become nuisance for many people, farmers for example, c) there is a perception that BJP’s simple majority at the Centre and 3/4th majority in state made accountability more difficult and that was the reason governance also suffered in a big way, and, d) people also think that BJP’s elected representatives are not qualitatively different vs. other parties.

2. Farm Loan WaiversTo Dampen Credit Growth Cycle

The NPA growth cycle affects credit growth cycle negatively. The recent farm waivers announced by many state governments and the speculations of a nationwide farm loan waiver by the Central government do not augur well for the banks’ credit space in India.

3. Are US Stocks A Buy Yet?

• 5%-like rallies on Wall Street are signs of a bear market not a bull market
• Bull markets require strong liquidity and low risk appetite, neither yet apply
• Risk appetite readings at minus 12.6 are still above the minus 40 criterion for an upturn
• Recent large fall in risk appetite consistent with upcoming economic recession

4. Monthly Geopolitical Comment: Redrafting of Global Map of Political Alliances to Continue in 2019

5. Direct Income Transfers Likely Soon; Universal Basic Income Possible By 2024 Funded by RBI Reserves

Direct income transfers to farmers are likely to become reality as competitive loan waivers are fast becoming a norm than an exception and every party is offering a larger waiver. 

Direct income transfers have been quite successful in the South Indian state of Telangana with KCR promising one at the national level if the Federal front (that he is proposing) is voted to power in the general elections. 

Cost of each of the measures (from loan waivers to universal basic income for all Indians) is between 0.7% to 2.7% of GDP with Universal Basic Income  (Rs 7620/individual for 75% of Indians) costing the highest. 

Even as initial fiscal costs are alarming, a gradual scale up (like in the Rural Employment Guarantee Scheme) and transfer of reserves from RBI in tranches could mitigate some fiscal impact. We expect the expert committee of the govt and the RBI to identify transferable reserves between Rs 1.0trn – 3.0trn. 

Overall, the freebies to Rural India will certainly power the consumption story strongly in 2019 with products sold in rural areas like FMCG, tractors and motorcycles expected to gain.