Themes for 2016

Here’s wishing everyone a very happy 2016 ahead. 2015 was a dismal year and a big let-down after the huge expectation created the previous year from Modi govt. The year was marked by volatility and quite a few initiatives launched by the govt. which should show positive results after some time. I think Modi has realized that campaign rhetoric is one thing, implementing those things quite another. Add to that the fact that this govt. doesn’t have the numbers in the Rajya Sabha, a must-have to pass any meaningful legislation, and the result is there for all to see. Very little business has been allowed to be conducted by the Opposition (mainly Congress) in the 2 parliament sessions held so far – Monsoon and winter. So much so that even the GST bill where most of the points had been agreed upon could not make it through. Now the govt. strategists would need to think of new ways to cross this hurdle of lacking numerical strength to pass the bills which it desires and which are dear to it. As can be seen, quite a few of the govt.’s election promises hinge on this solution, as they require the necessary bills to be passed in both the houses of legislature.

One of the things which I was betting on and which did not materialize was the GST Bill in spite of everybody agreeing in principle to its provisions and the govt. also accommodating the demands of the Opposition parties. As a result, the stocks which I had mentioned – Pidilite and Gateway Distriparks haven’t gone anywhere over the year. The only exception was Allcargo Logistics which has moved up smartly by about 20%. But that is due to its inherent business strength and not due to a conducive environment.

The Sensex continues to hover around the sub-30K mark. However, that doesn’t mean that there are no good stocks available at good valuations and more importantly good prospects, in spite of the prevailing environment. So it will be a good strategy now to focus on themes and sectors which will see their prospects improving dramatically due to 2 reasons – focus on domestic market, govt. moves and the resulting cascade effect these will have.

The parameters to consider would be return of equity (ROEs), return on capital employed (ROCEs) to judge the quality of the businesses the company is in. These are available in the public domain in the balance sheet of the company for the previous year. Stocks with reliable business model, strong anticipated sales growth, sustainable operating margins and cash flow generation and attractive ROEs and ROCEs should be on one’s radar.

The key themes to watch out for in 2016 will be:

1.   Crude oil prices – The positive downward trend of Crude is expected to continue this year as well and will continue to benefit sectors which use it as a key raw material, for e.g. paints, plastics, speciality chemicals etc.

The OMCs have made full use of the low crude prices to come back to profitability and the stock prices have doubled or tripled reflecting the positive sentiment. However, I think the story has run its course and the returns from hereon will be much more subdued than before.

2.   Power sector – The first concrete move from the govt. to address the ills of this sector came in the form of UDAY (Ujwal DISCOM Assurance Yojana) for financial turnaround of Power Distribution Companies (read more about it here. This should start showing early results this year onwards. However, it must be remembered that this sector suffers from structural issues which can’t be either wished away or removed in a couple of quarters. As has been seen before the real challenge before the govt. has been implementation of its well-meaning schemes and ideas. A positive start has been made and time will tell the story of the progress made. After zooming significantly last year, PTC twins have come down to more sedate levels now.

3.   Telecom sector – While the service providers are battling for market share and reducing margins due to intense completion and the likely emergence of Reliance Jio as a price warrior, the main beneficiaries in this sector will be the ancillary companies which don’t actually provdei the services but cater to the service providers themselves. For e.g. Bharti Infratel and Sterlite Technologies. Combine this with the govt. moves on Smart cities, where telecom is a major backbone, and u have a winning formula.

4.   Banking & Finance – With the insurance bill passed, the Insurance story is already on its way and the prices of the leading players reflect it. The next big thing which happened this year was the concerns of the public as well as private banks on the asset quality front. As a result, even private leaders such as ICICI and Axis have taken a severe beating. However, with the pedigree of the management in these 2 banks, they would surely get their act together in the year ahead. Axis Bank has been beaten down way too much for its asset quality concerns and once these are addressed, should be the first off the block. The other major area to keep an eye on would be Housing Finance. With the govt.’s moves on housing (Housing for all, Smart cities etc), these HFC should see good demand in the year ahead.

5.   Auto sector – This is one sector which flattered to deceive. Other than Maruti, on the back of its reach and new launches, no player can really claim to have done well. However, all is not gloom and doom here. Most of the players have certainly recovered from the lows they reached the prior year on the back of green shoots being visible. It remains to be seen if these shoots actually go on to become plants in the year ahead. I expect that the CV sector will certainly improve on the back of govt.’s initiatives in the Road sector. So Tata Motors and Ashok Leyland should do well here.

Having listed the sectors and the scrips within them where money can be made, here are some specific companies I expect to do well:

Axis Bank

This was one of the most promising banks till a year ago and has been beaten out of shape in the last year on the back of asset quality concerns. Much higher than expected slippages - sale to ARC of Rs1830 crore for Rs 650 crore, Rs 463 crore of restructuring and about Rs1500 crore of 5:25 refinancing diluted asset quality led to a steep fall in Axis Bank over the last year. However, PAT growth aided by a strong retail loan book growth has helped stem the fall and inspires confidence for the period ahead.

Considering the pedigree of its management and the economic recovery expected, I think it will be safe to buy into this at the current level which is close to its 52-week low of 430. Close to 90% of the stock is held by the promoters, DII and FII thus leaving close to about 10% of the stock for the retail public. This also shows the confidence long term players have in this stock. I would consider this a reliable bet for a long term portfolio.

MCX

This has been one of my favourites for a long time now. I have no doubt regarding its niche position and it provided the perfect opportunity when it suffered collateral damage due to the FT fracas. It has doubled since then, but recent developments have again made this a potential high flyer.

Some time back FMC was merged with SEBI. And MCX would be the biggest beneficiary of this move.

Coming to the valuations, it has a market cap of less than 4400 crore whereas it has cash equivalents of close to 1200 crore on its books. NSE, which has issues shares but is as yet unlisted, has a market cap of close to 30K going by the valuations its investors paid to get into it. Of course, NSE is much bigger player than MCX while MCX is purely into commodities. This also gives MCX a huge window of opportunity to expand the commodity trading space itself. And its only competitor is NCDEX which is again unlisted. Thus MCX has all the good things going for it – a niche business area, no listed peer and hence a listing premium, the opportunity to grow its business on its own terms and finally a reputed promoter Mr Uday Kotak who needs no introduction.

Due to the impending merger of FMC with SEBI, there were no new products of MCX which were granted approval. Now that it is a thing of the past, MCx should be able to launch new products and gain market share. Currently it has a market share of 80% in the commodities market. With new products, this should get a fillip.

Due to the market volatility over the last year, it has again come to sub-1000 levels and is quoting at attractive valuations. A must buy for any long-term portfolio.

Sterlite Technologies (ST)

I had first written about this company here on 21-Aug-14. This is a leading global provider of Telecom (Optic Fibre and Cables) and Power Conductors, from Anil Agarwal’s Vedanta stable. These products and solutions would typically form the backbone of any other components that would make up the smart cities. As things stand today, not many cities are geared up for this sort of thing yet. And if things have to be built from scratch, there would be a huge surge in demand for optical fibre and transmission lines which are ST’s forte.

Also, the govt. has re-initiated NOFN (National Optic Fibre Network), with the aim of providing broadband connectivity to over 2 lakh gram panchayats at a cost of Rs 20,000 crore. It aimed to leverage the existing fibre optical network of central utilities — BSNL, RailTel and Power Grid — and laying incremental fibre wherever necessary to bridge the connectivity gap between panchayats and blocks. This in itself will spur the demand for Optic Fibre which is a key product of ST. This is besides the demand from private players for broadband which again will require Optic Fibre.

With the Digital India initiative under which NOFN falls, dear to the govt., they would leave no stone unturned to see it successful, leading to a robust demand for ST in the period ahead.

The other booster for ST would be the govt’s official notification of the Smart Cities initiative (plans have been submitted by close to 100 states in Dec. ’15 for the development of Smart cities).

All in all, ST should be in a sweet spot, unless things go horribly wrong like in the case of the GST Bill which was near and yet so far.

Jamna Auto Industries

I came across this company during my research on the auto ancillary space. This is a very low profile company, though with strong strength in its core area of auto suspension products. It is the largest manufacturer in India of tapered leaf, parabolic springs, air suspensions and lift axles for Commercial Vehicles and third largest in the world. It has very strong international collaborators with NSK Springs of Japan for parabolic springs, and Ridewell Corp of USA for air brakes and lift axles.

Over the last quarter, all of their valuation parameters have shown a tremendous jump – revenue, earnings as well as ROCE (Return on Capital Employed). ROCE jumped 25% from 12% to 15% over the last year. And the management commentary is heartening in saying that they will focus on ROCE in the coming periods. ROCE is the parameter which indicates how well a company utilises its capital in running its business.

This company supplies to over 25 countries including global names such as Volvo, Suzuki etc. Back home, its clients include the CV biggies Tata Motors and Ashok Leyland. It has 6 plants in India with facilities in the vicinity of these companies for timely supplies.

The demand for company’s products remains strong in spite of the CV cycle not fully recovered yet. With the expected recovery in the CV cycle in the coming months, the demand for the company’s products should remain strong. The company is wisely expanding its capacity at its Hosur plant to cater to this growing demand.

The debt of this company is negligible. And the management has reiterated that all its future expansions would be dne thru internal accruals only and not thru borrowings.

The other positive thing about this company is that it has decided to pay out 33% of its net profit as dividend to its shareholders.

The company recently split its fv from 10- to 5/- to improve liquidity.

Considering the positive business outlook and management’s investor friendly approach, this should give good returns over the next few years.

Surya Roshni

This is a company which is into 2 major areas – Lighting and Steel. This would be a beneficiary of the government’s recent push to sell LED bulbs. The lighting industry is expected to do well in the period ahead, with the govt.’s push for housing, including Smart cities. Within that, the LED segment should contribute 30% over the next couple of years. Fans and other appliances business of the company has been doing well. The steel business has been a drag, but the lighting business is performing very well and the debt levels have actually come down.

The steel business again is a dark horse and is dependent upon the economic recovery. So both the areas hold promise in the year ahead.

This could very well go the Havell’s way if things play out well.

Besides the above, there are a couple of more stocks which are on my radar, purely because of situational reasons.

Sun TV – This fell out of favour mainly on extraneous factors rather than any fundamental concerns related to the business. The reason this time was the union home ministry denied security clearance to the company's 33 channels in early June, a move that could have resulted the cancellation of their broadcasting licence. Security clearance for the group's cable TV business was turned down by the government amid three pending criminal investigations against the company and its owner Kalanithi Maran. This led to the stock tanking close to 30% in a day from its previous close. However, this was opposed by the govt.’s own I&B ministry, thus showing division within the govt. ranks. I&B ministry approached the law ministry to seek the opinion of the top law officer on the issue after the Ministry of Home Affairs (MHA) denied security clearance to the network. And the AG supported the grant of security clearance, saying the corruption cases being investigated against the network's promoter cannot be the ground to deny permission. This again led to a jump of 8% in the share price.

Thus this was more news-driven rather than any business or corporate governance issue. In fact its operational parameters are quite strong in spite of the news flow around it From those lows in June, it has now risen nearly 50% in 6 months.

In early Nov. the company mulled a buyback of its shares and set up a committee for arriving at a price for the same. The company clarified that buyback was to reduce extra cash from the company and in the process will drive return on equity (ROE). It has an outstanding cash of Rs 750 crore on books. Promoters hold 75%, FII 16.61% and DII 2.64% in the Kalanidhi Maran-owned company. Thus the floating shares are hardly 7% in the market. This also shows the confidence of the long-term investors in the company. To add to this, recently MSCI added Sun Tv to its MSCI global standard small cap index, another thumbs up from a global body.

In the entertainment space, this is one of the fundamentally strong listed players and should find a place in a long term portfolio.

DCB Bank

Again, in a knee-jerk reaction typical of Indian markets, investors dumped shares of this promising bank, like there was no tomorrow. It tanked 20% in a day when it announced aggressive expansion plans to double its branches to 300 within a year in an effort to tackle increased competition for customer deposits in India. These were not to the liking of the market. DCB Bank then scaled back its plans -- to 150 new branches over two years – to assuage investor. However, investors still are sceptical and the stock is still down more than 30% than from before these announcements.

Again, there is nothing fundamentally wrong with the bank, and not too long ago, it was a darling of the markets, having moved from 40 levels to 130 in a couple of years. Once it starts showing good results in a quarter or two, things should come back to where they were before this fracas. So gains are meant to be had in such situations.

In the above 2 examples, Sun has recovered the lost ground in style, even going past the price it quoted before the dumping, while DCB is still to come to terms with it. It has a good retail franchise and no asset quality concerns which have plagued the likes of ICICI Bank and Axis Bank over the last year, thus making a good investment bet.

Let’s now pause a bit to see how my picks did last year:

Core Picks	Price as on 31-Dec-14	Price as on 31-Dec-15				Returns
Zicom Security Systems	178.6	132.6
Kalyani Steels	157.25	167
Capital First	366.55	410.65
Hindustan Zinc	170.35	146.4
L&T	1494.65	1275.45
	2367.4	2132.1			235.3	-9.94%
Berger Paints	201.2	268.25
Kansai Nerolac	198.53	269.65
HDFC Bank	951.6	1082.15
ICICI Bank	353	261.35
Tata Motors DVR	331.9	289.35
Ashok Leyland	51.35	87.9
Overall
	4454.98	4390.75			64.23	-1.44%

I have excluded the GST-related stocks (Pidilite, Allcargo Logistics and Gateway Distriparks) because the premise of their recommendation itself did not materialize. However, they still make it to my list because of their inherent strengths. It is only a matter of time before the GST Bill is passed and when it does, these are the ones which will be some of the biggest beneficiaries of this move.

As seen from the above table, most of the economy-related stocks failed to make a mark due to the lack of expected pick-up in the economy.

Also, I have not included the Power-related stocks mentioned last year as I had stated clearly that the returns in these will be visible only after 3 years from then, which will be another 2 years from now. So let’s wait and see how things pan out in 2 years time. 

All in all, nothing much to cheer about. So after a dismal 2015, here’s wishing all investors a very profitable 2016.