Diwali Dhamaka 2019

Here’s wishing everyone a great Diwali and a prosperous new year ahead. After the carnage witnessed in mid-cap and small cap stocks over the last year (which worsened over the last 6 months), the market appears to be stabilising. Though the rise in indices has largely been due to their large cap nature, where this category has done reasonably well, there are some mid-caps which have either been news driven or were beaten down way too much along with the market churn, much more than was warranted, which have regained some of the lost ground in the last few weeks.While it is true that this category of stocks has always traded at a premium to the market at most times, everybody was taken aback by the severity and impact of the fall ranging anywhere from 10% to 90% in some cases.

There were some major market-shaking events since last Diwali – the cascade effect of IL&FS default on the entire NBFC space, the govt’s quirky budget announcements of taxing the super rich (of which foreign investors form a significant part) and the US-China trade wars which had a global impact which cascaded to Indian markets. The IL&FS fiasco cascaded into an overall liquidity crunch so much so that the source of funding for NBFC practically dried up and some like DHFL have gone belly-up and others like Piramal Enterprises have halved from their year-ago levels. The sell-off in mid-caps and small-caps also happened in no small measure due to SEBI which launched the re-categorisation exercise based on market capitalisation. This led to a number of mutual funds selling off their disproportionate holdings of mid-cap and small-cap stocks across schemes to bring them in line with the SEBI mandate and their schemes’ categorisation as per the new classification. This couldn’t happen overnight and their effect was felt over the next few months.

While the govt. has rolled back the tax on super rich and has tried to reverse the tide by announcing corporate tax cuts, which will boost the bottom lines of quite a few companies significantly in these trying times, the key question of when the demand will again come to its pre-churn levels or even increase from those levels is a moot question.

And this has provided a window of opportunity, and a quite wide one at that, to grab some of the quality mid-caps at attractive prices, which will lay the foundation for compounded growth in times to come. After all, equity is considered, and has proven in no uncertain terms, to be a long-term game meant only for the patient ones. The current times are certainly testing this theory to the full.

The mid and small caps which have crashed over the last year are the very stocks which will bounce back with a vengeance once the environment becomes benign, or at least there are no negative signs. This will not be a broad-based rally like the bull run of the 2003-08 and will only reward the ones which are in sectors with positive outlook and/or have cleaned up their acts either on the management side or the business side.

As always, the focus should continue to be on companies with quality management and good corporate governance practices. Also, some of the companies have been beaten down for reasons other than their performance and this can only change once the non-technical parameters are sorted out. Following are some of the companies either in nascent sectors which are poised for growth in the coming years, or have suffered collateral damage in the market meltdown.

Nippon Life AMC (NLAMC)

I had recommended this earlier as well, and now post management change (Nippon Life buying out Reliance stake), there is all the more reason to go for it.

In the MF industry, the penetration has certainly been significant. Even in times of a weak market when the indices fell by a few thousand points, the SIP book has remained stable. For NLAMC, the retail AUM has now reached 55% of its total. The ADAG group issues which haunted this stock earlier are now behind it with Nippon Life taking full control of it. Now the focus will be on improving business fundamentals. After being on top for some time few years back, due to management and group issues, this company had to let go of its top ranking and had slipped from its former #2-3 rank in the MF industry. It is now in a position to regain its lost stature in the next 1-2 years.

There are only 2 listed AMC in the market and HDFC AMC commands a premium over reasonable valuations, So NLAMC is in the right position to reduce this gap and provide great returns. This is a structural story and hence will continue a compounded growth over the years to come. It should be considered as a portfolio stock to be held for years to come to see the real benefits of growth for a sunrise industry. A similar thing happened in the Paint industry where only Asian Paints, a pedigreed stock, ruled the roost not too many years back. In the last 5 years, Berger Paints and Kansai Nerolac have given eye-popping compounded returns, way ahead of Asian Paints, just because people only looked at the leader and not the next few below it who were snapping at the leader’s heels. And the market expanded favourably to give the next in lines an opportunity which they grabbed with both hands. The same could well turn out to be true for NLAMC.

Aditya Birla Fashion & Retail (ABF&R)

Another pedigreed stock from the AB stable, this too has had a hammering over the last year or so from the levels it enjoyed earlier.

After integrating Pantaloons with itself, ABF&R is planning an aggressive store expansion of Pantaloons’s Lifestyle stores. It has plans to expand to 400+ such Lifestyle stores and 60+ Pantaloon stores. From its earlier avatar of a premium apparel maker (post Madura Garments merger), ABF&R is now in a position to straddle multiple price points in the apparel chain from low-cost to premium branded clothes, and these stores will reflect that. Pantaloons is expected to improve store productivity and margins with a higher focus on private labels and a higher mix (above 80%) of margin-accretive fashion products.

Another emerging segment which this company is tapping is that of innerwear. Page Industries is the only listed branded premium innerwear maker currently and enjoys premium valuations due to this. This segment gives ABF&R a good way to improve its margins due to the premium products in this segment that it can market. This segment has been growing well for it in the last few quarters and giving some competition to Page Industries, though there is still some distance between the 2. It is aiming to expand in the women’s inner wear segment (with already significant presence in men’s inner wear – growing at 50-60% annually). This, coupled with cost efficiency drives in the brands business, is expected to improve the EBITDA margin in the coming years.

This company enjoys a high RoE, strong FCF generation and should continue to show strong growth in the coming years.

Currently quoting at about 204, it can easily provide a 20-25% upside from here.

Zee Learn

The education sector has seen great interest from investors post the much-hyped acquisition of Euro Kids, Euro Schools, Kangaroo Kids and Billa Bong High chain by the marquee global PE fund KKR. Market sources believe that the deal was inked at around 2000 Cr Enterprise Value which translates to an EV / EBITDA multiple of 20 given the estimated Euro chain EBITDA of around 100 Cr p.a. Using the same methodology, Zee Learn is likely to be valued at an Enterprise Value of 4000 Cr given that its EBITDA this year is likely to be around 200 Cr as per market estimates. If the above deal goes through then the Zee Learn share price may get re-rated around 3-4 times from the current lower levels that it has been languishing for the last few months. Also, this deal may be one of the largest ones in the recent past. Blackstone had also invested in the Test Preparation major, Aakash, recently at an Enterprise Value of around 3500 cr which may get surpassed by the Zee Learn deal if it goes through. 

Zee Learn is a diversified Education Company with its network having multiple offerings from Pre K, K12, Higher Education, Test Prep, Tutorials, Vocational, Skilling, Manpower & Training and Digital Education. 

Zee Learn has grown its turnover and EBITDA at more than 50% CAGR in the last few years. It is has more than 4 Lakh students and 50K teachers/staff in its network. Its Brands include market leaders like Kidzee (Asia’ largest Pre K chain), Mount Litera (India’s top three K12 chains), Mahesh Tutorial (leading Test Prep & Tutorial chain) and Robomate. The Zee Learn Network has a massive pan India presence with more than 3000 schools / centers present over 800 plus cities which collect revenue of around 2000 Cr p.a. 

Currently quoting 50% below its 52-wk high, in spite of rising 45% above its 52-wk low, it can still give good returns considering the situation Zee promoters find themselves in.

Finolex Cables (FC)

Finolex Cables is the third largest manufacturer of electrical and telecommunication cables and also polyvinyl chloride (PVC) sheets for roofing, signage and interiors in India. It counts among its strengths a diversified product portfolio, wide distribution reach, backward integration to manufacture key cable components like copper rods and its cash and carry business model due to higher B2C mix.

The domestic wire and cable market is growing 10-12 percent p.a. and the current market size is estimated in excess of Rs 52,000 crore. Polycab is the largest player with a double-digit market share. Havells, Finolex and KEI follow with an almost equal share of 5% each.

FC has 5 manufacturing plants across India and 28 depots to service its 800 distributors catering to 4000+ dealers. It also has JV with foreign companies such as Sumitomo of Japan for EHV cables, marketing JV with Corning of US for optic fibre technology and technical collaboration with NSW of Germany for cables for submersible pumps.

In recent years, the company has diversified to change from being a cables company into an electrical products company (a new term FEMG for Fast Moving Electrical Goods such as electric switches, LED lights, fans and such). It is banking on its wide distribution network and brand recall in this initiative. The company first entered the electrical switches and lighting segment, leveraging its widespread distribution network in the country, and then introduced switchgears, fans and water heaters. New products within FMEG sector grew by more than 10% y-o-y each in FY19, albeit on a low base. Considering the intensely competitive market in this segment, it is treading cautiously in this area.

The interesting thing is that it owns 32% in Finolex Industries, the pipe-maker, which is expected to have a good run given the demand for PVC pipes on the back of govt's drive for water schemes and housing for all. This makes it still cheaper on the valuation front. And the fact that it has consistently enjoyed double digit margins in this competitive industry speaks a lot for the management.

Currently it is quoting at 380 close to its low of 335 and has seen a 52-wk high of 540. Considering govt’s focus on affordable housing, chances for growth are high and it should get back its growth trajectory pretty soon.

Spencer Retail (SR)

This is a new kid on the block in the listed retail space after KB’s Future Retail and Tata’s Trent.

Though this got listed only in Jan ’19, it has been around for 10 years now. It had stores in tier-2 metros such as Pune and in less expensive ones like Chennai.

The Indian organised retail market appears set for a stellar run, with its size likely to triple by FY25 as per a recent research report by Motilal Oswal. While the industry is undergoing constant disruption, one thing has remained steady – consumers’ affordability is on the rise and aspirations are growing more than ever. This trend particularly bodes well for food & grocery (F&G) and apparel categories.

Though the demand exists, all is not rosy yet in terms of financials for the retailers and it has taken quite a while for them to get their maths right. Consider this - Trent Hypermarket, which has been around for around 16 years, saw losses widen to Rs 90.50 crore in FY18 from Rs 52.49 crore in FY17 partly on store rationalisation costs. Again, not able to sustain prolonged losses which accumulated to 712 crore at the end of FY17, Shoppers Stop sold Hypercity to Future Retail for 655 crore in October 2017. Godrej’s Nature’s Basket, a premium supermarket chain, with outlets across 2000-6000 sq ft, has been around since 2005 but is still floundering.

Spencer’s managed to break even at the EBITDA level for the first time in FY18 after the parent company took over its debt of Rs 280 crore. The smaller debt helped the company to narrow its net loss to Rs 30 crore compared with a net loss of Rs 108 crore in FY17. And in the first half of ’19, it has shown a positive PBT of 5.2 cr. SR added 19 stores this year, most of which are doing well.

Management plans to accelerate the pace of store additions, increase the share of private labels and apparel with the recently launched value apparel brand 2Bme and ramp up omni-channel presence.

Similar to insurance and AMC business, though Retail has been around for close to a decade or slightly more, this is still a sunrise industry. It has taken 10-15 years for the established biggies such as Tent and Future to get their act right, but the advantage that SR has is that it has seen all the mistakes the others have done over the years and also some of its own. It therefore is in a position to grow judiciously within its means.

Post its demerger from CESC, SR listed in Jan ’19 at a price greater than 200, and is currently quoting at 78. Given time, this will surely provide great returns, albeit at a measured pace, at least initially. One thing which should be remembered but almost 90% of the people forget, is that your returns in the market are determined at the levels you buy the stock. If you had bought Reliance in the first week of January 2008, you still have not made any money in Reliance Industries. For 9.5 years, you have been just preserving your capital but if you had bought Reliance in the third week of October 2008 or the first week of March 2009, you would have made great returns.

Before concluding, let’s look at how last year stocks have performed:

  

	Market Cap class	Price last Diwali (Rs.)	Price this Diwali (Rs.)	Gain/Loss (%)
Yes Bank	Mid-cap	216.00	52.15	-75.86%
Maruti Suzuki	Large-cap	7135.45	7457.50	4.51%
Max Financial Services	Mid-cap	392.85	404.65	3.00%
GNA Axles	Small-cap	392.40	251.45	-35.92%
Godrej Agrovet	Mid-cap	530.05	506.45	-4.45%
Total		8666.75	8672.20	0.06%

So from last Diwali, the portfolio is practically flat. Considering the carnage in mid-caps and small-caps over the last 6 months and the performance of the indices of both these categories, mid-cap indices fell 3-7% and small-cap 10-11%, the performance of this mid-cap heavy portfolio should count as a reasonable one, though that may not be something to be proud of. Maruti Suzuki and Max FS were the only 2 stocks which kept their heads above water. Yes Bank (asset quality and promoter issues) and GNA Axles (M&HCV auto sector slow down) were the ones hammered badly. However, in the light of recent developments, I am still positive on both of these and given some time, a year or two, they should get back their mojo, barring unforeseen circumstances beyond their control.

The current set of stocks is also from mid-cap and small-cap categories and considering that they have already been hammered to rock-bottom, the only way for them could be up.

HAPPY MUHURAT INVESTING.