Diwali Dhamaka 2016

Here’s wishing everyone a great Diwali and a prosperous new year ahead. As with last year, the market has kept up its volatility with new highs as well as precipitous falls at various times in the year, and not every time for sensible reasons. It thus continues to be a stock pickers market. 

After the initial hiccups, and to some extent the belying of lofty, if unrealistic, expectations, Modi sarkar seems to be settling down with a few accomplishments on the national as well as the economic front. While the surgical strikes against Pakistan will come in handy for the govt. to show that it means serious business with notorious neighbors and won’t take things lying down as was done by oast govts., the passing of GST Bill (the Const. Amendment, not the actual one which will come up in the winter session shortly) will no doubt boost its morale as well as that of the industry no end.

As I have been mentioning over the last 2 Diwali blogs, it never pays to get carried away in the stock market, in either direction, especially in India. So any serious dip in quality stocks with proven managements should be considered as an opportunity to buy into those shares at lower prices, thus increasing the chances of reaping better gains, than would otherwise have been obtained. The recent Tata saga, which is still unraveling, is a classic case in point. Though spat between the top management is always a serious issue, if it doesn’t directly impact the businesses of the companies themselves, then it should be allowed to play its course without worrying too much about the company’s performance.  Tata Motors will not sell any less or more JLRs purely because either Cyrus Mistry or Ratan Tata is at the helm of the holding company. It would have been a different matter if either of them were directly heading the company.

In the last 1 year, the mid and small caps have outperformed the large caps by a wide margin. This has led to the situation where quite a few of these stocks are running far ahead of their fundamentals at elevated levels. This however should not be taken as a sweeping statement. There are pockets in midcaps which are still quoting at reasonable, even if high, valuations primarily because of their growth prospects going ahead. And these companies are likely to give rich dividends in the years to come if one has the patience to hold on to them for a few years through thick and thin. Some of the NBFCs like Manappuram Finance (which has tripled in the last 1 year) and SKS Micro are cases in point.

So given that this is a buyer’s market now, where should u place your bets? The focus this year has been on Consumption theme as well as the economy. Needless to say, management quality, business domain and growth prospects should always be primary factors while deciding on buying any stock. Some of these stocks have been beaten down due to a bad quarter here and there, but their pedigree remains unquestionable. 

Jain Irrigation Systems DVR (JIS)

Jain Irrigation Systems (JIS) is currently the world’s second largest and India’s largest micro irrigation company. Another little known feature is that JISL is the largest global player in mango processing. The stock was once the favourite of cognoscenti investors owing to its dominance in the Micro Irrigation systems (MIS) and soared to an all-time high of Rs. 265 in August 2010. However since then, it has been a downhill journey due to some ill-times moves by the company.

The reason the Company fell out of favour was because it changed its business model. It earlier used to sell irrigation equipment to farmers on credit which created severe stress on the working capital. To resolve the working capital problem, the Company demanded upfront payment from the farmers. However, the impoverished farmers had no money to pay for the equipment with the result that sales slumped and profitability went for a toss. To compound the problems, the Company availed of massive loans of up to Rs. 4,200 crore to enter into unrelated diversification. The huge interest burden itself crippled the Company.

However, that is now all set to be history. Over the last year, the Company has taken a series of strategic decisions which are designed to move it out of the unrelated businesses and reduce debt. The market has lost sight of these developments and has not given the Company any credit for its efforts.

Govt’s  ‘Pradhan Mantri Krishi Sinchai Yojana’ under which nearly Rs. 50,000 crore is be spent over the next five years on irrigation and allied farming related matters, will catapult Jain Irrigation back to the growth path. The fall in oil prices as well as polymers will also improve the margins for JIS.

The govt. has vowed to complete 99 major and medium irrigation projects by 2019 and bring 7.6 million hectares of land under irrigation in some of the most drought-prone regions of India. A long-term irrigation fund of Rs. 20,000 crore under the National Bank for Agriculture and Rural Development (Nabard) will also be created to fund irrigation projects.

All the above, with the addition of a good monsoon this time round, augur well for JIS, having a monopoly in drip irrigation.

The other 2 businesses of JIS – Piping products and Food processing are also high-growth areas due to govt’s initiatives in agriculture and food processing industries.

All the segments JIS is in are thus high-growth areas and have the potential to reap rich returns over the next few years.  Also, JAF Products Pvt Ltd (the promoter group company) infused capital worth Rs 112 crore in the form of equity (at a premium of Rs 78 per share on the face value of Rs 2) in FY16. It has already risen by 38% over that price and if things go as projected above, powered by its growth businesses, it could well be a multi-bagger in the years to come.

For retail investors, I would always go for the DVR which though trades at a discount to the parent, gives a better dividend and would always rise in the same proportion, thus making it cost-neutral and a better option.

L& T Finance Holdings (LTFH)

With a pedigree such as the one it has, this has only flattered to deceive so far. Since its issue @52 in July ‘11, it languished below this price for quite a few years immediately following the issue. However, the last couple of years, it has managed to break its shackles and has given great returns to investors who entered it post the IPO at a lower price. It is only now that the original IPO investors have some reason to smile.

However things are changing for the better at a fast pace as LTFH has embarked on a restructuring drive over the past year or so, with advice from McKinsey. It has been looking to prune several of its unprofitable units, including the asset management and alternate investment business, to concentrate on its hardcore infrastructure, rural, and wholesale financing as the company aims to improve the RoE to 18-20 per cent by 2020. 

On valuations LTFH is trading at P/B of 2.65, cheaper than its peers such as Cholamandalam Finance (5) and  Shriram City  Union Finance (3.55). And the restructuring has started to yield results. Company has improved its asset quality with GNPA coming down to 4.58% in Q1FY17 from 5.45% in the same period last year. Net NPA also improved to 3.13% from 4.43% in the same period. As the company has started focusing more on retail financing and low yielding assets, the asset quality stands improved.

The NBFC sector has had a massive run in the last 2-3 years or so, with some such as Manappuram Finance (up 3 times in the last year alone) & Cholamandalam  (up 5 times in the last 3 years) running up massively and therefore have relatively less steam left, due to expensive valuations. With the economy on the verge of a turnaround in the next year or so, LTFH, with a renewed focus on its core areas should yield good returns.

Kokuyo Camlin (KC)

This is an MNC stock and has been lying low in the current bull market. And the surprise is that it is not even dependent on the economy per se. The kids will go to school no matter what the interest rates are and will need most, if not all, of the things which KC makes. Agreed that it has had a dismal quarter recently, but there are a lot of triggers for KC to give rich returns

• The company has set up an integrated, state-of-the-art manufacturing facility at Patalganga, spread over 56,600 sq.mts. (14 acres) of land and, supposed to be “the largest stationery plant in the Kokuyo Group”. This is likely to benefit KC as economies of size, scale and scope unlock immense new potential in procurement, logistics, production and delivery. This may well be the inflection point the company was looking for.
• Promoters (Japanese MNC Kokuyo S&T Ltd.) hold 75% of the stake and some astute HNIs , among them Ramesh Damani (one of the most astute investors on Dalal Street) and Anand Rathi hold about 8% in KC leaving only about 17% of floating stock.  The thus stock has low liquidity which can work out to the advantage of investors owing to “supply scarcity” and “mis-pricing” of the stock.
• With 75% stake, there is always the possibility of delisting at some point in time. Ricoh India, also a subsidiary of a Japanese behemoth, has already unsuccessfully attempted delisting on two occasions. If this materialises, KC will shoot thru the roof as has happened in other cases unfailingly.

 A good company in a bad time is always a catch. And such opportunities should be grabbed with both hands.

Aksh Optifibre

Aksh is a company whose time has finally come.  I had written about Sterlite Technologies earlier and at that time as well I had mentioned that optical fibre business is likely to see good times ahead. Other than Aksh, the other 3 players in this area are Sterlite (which is the leader), Vindhya Telelinks and Birla Ericsson.

In India from 2000 onwards there was a boom in cell phone/telecom and internet usage but sadly the required optical fibre demand did not materialize in that period.. But instead of foraying into real estate / infra the promoters of Aksh kept improving the company by expanding capacity, doing backward integration and focussing on various facets of the same business - more particularly becoming leaders in production of FRP rods and also FTTH (Fibre to the home). Another foray in a field similar to FTTH was the e kiosk business in Rajasthan.

Another noteworthy aspect of Aksh has been that capacity expansion has been undertaken in a slow and steady manner without adding much of debt...therefore, now that optical fibre cable demand has finally come to India due to Digital India, Smart cities, 4G, FTTH and e- governance. Aksh has some unique features which will serve as at least a temporary moat (for 5-7 years).

•  It is fully integrated Optical fibre cable manufacturer focussing solely on this business and having developed considerable expertise and reputation and supplying quality goods to a host of big guys.
• It has very less debt and that combined with backward integration makes it a low cost producer of Optical fibres
• Its capacity expansion is perfectly time and will enable the company to grow rapidly, while there is no significant capacity addition by other two players Vindhya and Birla Ericcson.

Currently trading at 23, this has the potential to be a multi-bagger going by the prospects ahead.

Aditya Birla Fashion & Retail (ABFR)

This is a play on the brands in the premium apparel segment. Arvind has already multiplied manifold in the last 2 years and so has Raymond. This will be a beneficiary of the re-rating of brands the way it happened with Arvind and Raymond. Post its split with AB Nuvo, this hasn't really established its own identity. This is one stock in the Textile segment which is waiting to be discovered.

This company emerged from Madura Garments which was already known for its premium/upmarket brands such as Louise Phillipe, Van Heusen and the slightly lower Peter England. These brands have now come under ABFR fold. After firmly establishing themselves in the shirts and trousers category, these brands have now also expanded into other related segments of men's dressing such as belts, handkerchiefs and shoes, thus providing a complete wardrobe for a man. And now the logical expansion currently being targeted is women. Van Heusen already has a women's range and is probably only one of the few brands in the women's wear category which is generally catered to either by proprietary brands launched by the retail store chains such as Shoppers Stop or the unorganized sector. So there is ample scope for establishing themselves into this segment. And these brands have already learnt the ropes of marketing premium brands to the white-collar population.

The other major advantage that ABFR has is the recent merger of Pantaloons with itself. Now Pantaloon caters to the unbranded mid-market/economy segment which again is a big market. Here the competition is from local/regional brands such as Cambridge in Mumbai. Given the reach Pantaloons has, due to its long presence in this segment, expanding its share in this market also shouldn't pose major problems.

All in all, here is a company which straddles the entire segment from mid-market to premium in men's as well as women's wear waiting to catch market's eye. And the good part is that this segment is a high-margin business which augurs well for this company.

Though the fundamentals are not anything great to write about currently (it is making losses but these have reduced sequentially), this should be accumulated now as well as on occasional dips for great returns as market re-rates this stock..

Before concluding, let’s quickly look at the performance of last year’s recommendations:

Stock	Last Diwali	Current	Difference	%
Federal Bank	53.70	81.95	28.25	52.61
Motherson Sumi Systems	265.65	331.10	65.45	24.64
L&T	1347.45	1477.90	130.45	9.68
ICICI Bank	262.40	276.85	14.45	5.51
Ashok Leyland	89.50	90.25	0.75	0.84
Eros International	256.15	194.95	-61.20	-23.89
Overall	2274.85	2453.00	178.15	7.83

All prices in Rs.

So since last Diwali, this portfolio has given a return of 7.83% slightly less than 8% which is what Sensex returned. Over the same period Nifty gave 10% and mid-caps a whopping 22%. Given the circumstances, it is at best an average return, and could certainly have been better. While Federal Bank and Motherson Sumi delivered on expected lines, couple of stocks like ICICI Bank and Ashok Leyland didn’t perform as well as expected giving muted returns and in the process bringing down the overall portfolio returns. However, I believe that this set of stocks, except for Eros International which has not yet set its house in order and governance issues still haven’t been settled, certainly has the potential to perform well going forward and should certainly be retained and even averaged by adding more at the current levels as their growth prospects remain strong.

The current set of mid-cap stocks will hopefully return a far better figure next year.

HAPPY MUHURAT TRADING