In this briefing:
- India On Ground: Local Fund Managers Still Debate Valuations,OK with News Flow but Expect Volatility
- India Banks – The Roadmap Ahead
- Tobacco: A Framework for Analyzing the Sin Sector from an ESG Perspective, with a Focus on ITC
- Titan Co Ltd (TTAN IN)
- State Assembly Results: Setting up a Direct Clash Between Indian Voters and Global Investors?
1. India On Ground: Local Fund Managers Still Debate Valuations,OK with News Flow but Expect Volatility
Last few months have been stressful for domestic fund managers and more than the sudden market movement, much increased volatility even in large caps has led to more anxiety for them. When we speak with some of the local fund managers, we get the sense that, a) the earnings season was mixed though revenue expectations were largely met for most companies and the worry was miss on profitability for some, b) there is still not high level of comfort on valuations and though correction came as a relief, the cash levels were not sufficient to take advantage of the situation, c) melt down in mid/small caps affect them less than big correction in large caps and that is why sharp movement in names like Tata Consultancy Svcs (TCS IN) , Infosys Ltd (INFO IN) and Maruti Suzuki India (MSIL IN) had hurt them much more, not to mention the volatility in Yes Bank Ltd (YES IN) and Sun Pharmaceutical Indus (SUNP IN) which had different kind of issues.
Most of them also think that some of the recent controversies such as RBI vs. Govt were completely avoidable and reflect political mismanagement than anything else. BJP’s loss in recent assembly elections is also negative but this was not completely unexpected because the margin is really small and things could have gone either way. In fact, some of them also say that the main Opposition party, Congress has not been able to completely exploit the failures of BJP Govt politically and appointment of RBI Governor is just like any other Govt official and media was unnecessarily and excessively focused on it, much more than what is warranted fundamentally speaking. However, silver lining for them is that some other market heavyweights such as Reliance Industries (RIL IN) and Hindustan Unilever (HUVR IN) have been steady.
While there is not much clarity on direction for the markets in next six months, the expectation is that volatility in local markets is likely to continue in 1H CY19 for three primary reasons, a) both crude and INR will continue to play a key role in market movement and expectation is that they will remain volatile, b) how the global macro factors such as trade war and relative attractiveness of EMs will play their role is not clear, c) the political factors and related news flow will drive the markets and though people still expect BJP may return next year (albeit in a coalition and with reduced mandate post 2019 Lok Sabha elections), the comfort levels have dwindled compared to how people were looking at it six to eight months ago. Among the specific sectors for the market, the interest levels are higher in FMCG and BFSI. People don’t expect IT to do badly but optimism has come down and Autos have also been a disappointment over last few months.
2. India Banks – The Roadmap Ahead
With the Reserve Bank of India (RBI) now effectively run by the government, there are likely to be discernable red flags ahead. We must expect that banks like State Bank Of India (SBIN IN) and others will overtly act as providers of liquidity. This will be both to struggling companies but also cash-strapped non-banking finance companies (NBFCs). In quarterly data this should show up in bank-specific figures, monetary numbers but also in corporate debt levels. It will be interesting to see if debt levels rise more for fragile indebted companies than others. Defaults should rise as well. This is because companies now realize that the government is running credit creation to support debtors, and will find it unjust to service a loan when others are not being penalized for default; at the margin they will choose not to pay. This goes to the well-known situation that occurred in Thailand after the 1997 crisis where the term was coined ‘can pay, won’t pay’ for these types of debtors.
3. Tobacco: A Framework for Analyzing the Sin Sector from an ESG Perspective, with a Focus on ITC
Contrary to the perception that the rising adoption of socially responsible investment practices has caused Big Tobacco to be shunned by portfolio managers, our shareholding analysis shows that institutional holding in most of these ‘sin’ stocks has increased in the last 4 and 8 quarters.
Nevertheless, Big Tobacco suffered a pounding in 2018. Investors had bought into tobacco premising reduced risk products (Eg: e-cigarettes, Heat Not Burn products) would reduce regulatory risk and reverse decades of sales decline. As it turned out, regulators frowned at the popularity of vaping amongst teens in the US, calling out companies for baiting youngsters into long-term smoking habits. Regulators also told off companies for marketing e-cigarettes and HNBs as healthier options, as tobacco still kills.
Ethical portfolios with negative screens (for example, ones that will not invest in tobacco stocks) have underperformed in the long-term past. There is a growing tribe of funds committed to responsible investing with positive ESG screens. For such funds, we present in this insight a framework for analyzing the sector from an ESG perspective. A deep dive into ITC Ltd (ITC IN), the only cigarette major to turn in a positive performance this year, vindicates, in our view, its efforts to materially de-risk its asset and revenue profile, coupled with very high levels of commitment towards community development.
4. Titan Co Ltd (TTAN IN)
Titan Company Limited manufactures and sells watches, jewellery, eyewear, and other accessories and products in India and internationally. The company operates through four segments: Watches, Jewellery, Eyewear, and others. It is one of the few companies operating in organised jewellery retail industry of India. We visit stores & markets in Kochi (Kerela) and Chennai (Tamil Nadu), the biggest consumption markets to understand structural changes that have taken place in the industry, with an objective to tweak our revenue and margin estimates. We believe consensus might be underestimating growth from the jewellery segment which is the largest contributor with 81.60% of Sales as of FY2018. Our revenue estimates for FY19 and FY20 are 5.8% & 2.98% higher than consensus, primarily based on higher than expected market share gains from unorganised players. Our EBITDA margins for FY 19 & FY20 are 1% & 1.30% higher than consensus estimates primarily based on product mix which is in favour of studded jewellery and operating leverage as sales across stores pick up. Our EPS for FY19 & FY20 is estimated at INR 18.60 and INR 24.26 per share which is higher than consensus by INR 2.47 and 4.05 per share for FY 19 and FY 20. Based on an average forward multiple of 49x we arrive at a target price of INR 1187, representing a 30% potential return from current market price.
5. State Assembly Results: Setting up a Direct Clash Between Indian Voters and Global Investors?
The results of the state assembly elections especially of Rajasthan, Madhya Pradesh and Chhattisgarh reveal the growing dissatisfaction of the electorate with the economic policies of the ruling Bharatiya Janata Party (BJP). BJP policies such as demonetisation (which was initially hailed as a brilliant decision) and the manner of implementation of the Goods and Services Tax (GST) dealt a severe blow to employment-intensive sectors like agriculture and the micro and small industries. The BJP had also allowed the agrarian sector in India to bear the burden of deflation, causing widespread peasant disenchantment, which became visible in massive farmer demonstrations culminating in the recent gathering in Delhi. Global investors should be prepared for significant increases in government expenditure on rural welfare schemes and farm income support to alleviate rural distress. In the absence of surpluses from the Reserve Bank, the government would have to expand the fiscal deficit for such schemes. If, on the other hand, the newly appointed RBI governor transfers the realized portion of the central bank surplus (the contingency reserve) to the government, such expenditure will weaken the central bank’s balance sheet at a time of global volatility. For the global investors the India risk has only increased.
