Themes for 2020

Here’s wishing everyone a great 2020.

Calendar 2019 proved to be a mixed bag with the indices touching new highs in the last month of December and a disaster for the mid-and-small cap stocks as they were hammered out of shape during the course of the year. And the good ones among them also suffered collateral damage. This also means that there was an opportunity to accumulate such gems gradually over the last year and wait it out for them to start bouncing back to their pre-crash levels. On the sectoral front, autos were the worst hit accompanied by real-estate. And among the auto sector, CVs have been the worst hit. Now the industry is pinning its hopes on the scrappage policy for old vehicles, which will lead to a demand for fresh vehicles, and the BS-VI emission norms from April 2020. For the PV segment, though there were a few bright sparks in the festive season, it is still too early to rejoice. The common theme impacting these sectors was of course the choking of fund supply from NBFCs which continued their dismal run from late 2018. And going by the current scenario, it doesn’t look that they are going to go anywhere in the next 6 months at least. The other noticeable thing among NBFCs was that the bigger ones were still stable with the likes of Bajaj twins – Finance and Finserv, as well as HDFC group stocks doing exceedingly well even in this gloom and doom situation. So the trend appears to be that the stronger ones will go from strength to strength while the weaker ones will either be gobbled up by the bigger ones or will just shut shop. We have seen the state of DHFL, SREI Infra which fall in the former category.

The note of caution however is that this index rally has been driven only by a handful of stocks and mostly from the BFSI space– RIL, HDFC, Bajaj twins, Kotak Mahindra Bank and the like, while the broader market is yet to revive, as seen by the state of mid-and-small cap stocks.

While the govt. has been doing its job with a series of moves such as regular rate cuts and reduction in corporate tax rates, not to mention a slew of other measures for NBFC and real-estate sectors, the effect of these is yet to be seen. It is seen that such macro-economic moves usually take time to play out over a couple of quarters at the minimum. So we will just have to wait for at least a quarter more to see the fruits of these moves, assuming no global disruption in the interim. The bright side for equities is a stale outlook on oil and commodities in general, low core inflation and a good monsoon. Things are also looking up for bad asset resolutions after the Essar settlement in NCLT recently.

While the supply side has been adequately catered to, it is the demand side which is a worry. And the govt. has hardly done anything in this area. Tinkering with personal IT rates in the coming budget in a month’s time could be a step in this direction, though how much this will really aid demand is a moot question.

The key theme in 2020 would certainly be Infrastructure, govt’s move towards increasing consumption and agri sector, which again covers everything from fertilizers, seeds, and tractors to small-ticket financial companies/NBFC which have a prudent model. These sectors would certainly benefit from the govt’s thrust in this direction. Also, there are some structural stories which have emerged in the last year such as Small Finance banks, Chemicals, Infrastructure etc. which should certainly merit attention.So this year’s stocks are based on the above themes. Let’s take a look:

Ujjivan Small Finance Bank (USFB)

A subsidiary of Ujjivan Financial Services, an MFI, this gave a blockbuster listing in excess of 50%, one of the key reasons being reasonable valuations. Even at the current price of sub-60 it has some steam left in a relative sense. A strong listing was expected after the saw hefty subscription of 166 times, becoming the highest subscribed IPO since January 2018. The category meant for QIBs was subscribed 111 times, NIIs 473 times, while the same for retail investors stood at over 49 times.

USFB's fundamentals look decent given its sustained growth in advances, improving asset quality, sound capital position and strong diversified geographic footprint. The company is customer-centric organization with multiple delivery channels. Also bank's pan-India presence along with gross NPAs being the lowest and having the second highest provision coverage ratio among the small finance banks in India, as of March 31, 2019 depicts strength in fundamentals of bank.

Going forward, overall outlook remains optimistic on USFB’s scope of business growth with well managed asset quality and higher provisioning resulting to higher return ratios comforting investors. The recent appointment of Nitin Chugh (ex-HDFC Bank Digital Banking Head) should aid the bank's liability and non-MFI asset profile. Analysts expect a price in the range of 80-100 over the next 1 year, which implies a growth of at least 33% over CMP.

Sudarshan Chemical Industries (SCI)

Speciality chemicals is that one space which was hardly affected by the global cues or liquidity crisis in last one year. The sector is thriving well and has given some tremendous returns during this year. The key triggers behind the sector rally were earnings growth and healthy domestic demand.Pune-based Sudarshan Chemical Industries is one such stock from this space.

SCI, India’s largest pigment producer, appears to be back on the growth path due to its high revenue visibility from ongoing capacity expansion for specialty products.Its products are used in industries that make coatings, inks, plastics and cosmetics. In daily life, the pigments are used in the making of nail paints, skin creams, eye shadows, and pencils.

Pune-based SCI is investing around Rs 300-320 crore in the current year and about Rs 200 crore next year to expand its capacities, which will rise 40-50 per cent in the next three to four years. Existing capacity utilisation is north of 70%. Global chemical companies such as Clariant and BASF are planning to exit the pigment business, which is worth around $10 billion. Of this, organic pigment where SCI has greater presence accounts for half the total. SCI has 2% global market revenue share of the global organics pigment market, according to the company’s annual report. The exit of global biggies will help the company improve market share.

SCI is increasing focus on the high margin specialty pigment, the share of which has consistently risen the past five years. With the addition of new capacities, the proportion of the specialty business is likely to further improve. Growth of the specialty chemical business of SCI has outperformed the non-specialty business. Consequently, the company posted 12% revenue growth annually in the last decade. This trend is likely to sustain, with the company adding 25-35 new products every year. The total product portfolio has reached more than 400. Despite the industry appearing to be commoditized, given that every product is customized for every customer, it becomes an entry barrier for new players. In addition, costs are lower for the India-based manufacturer. The export share rose to 46% in FY19 compared with 39 % in FY13 as its global reach spread to 85 countries.

In 2018, many chemical companies in China were shut down due to growing environmental concerns. This led to an increase in the manufacturing of specialty chemicals in India to ensure an uninterrupted supply in the market.We have seen how chemical companies have given robust returns over the last few years, with the likes of Vinati Organics(~117% in the last year), SRF, the largest manufacturer of refrigerant gases in India (~78% in the last year) and Deepak Nitrite(another promising prospect from this space) turning multi-baggers. Whether SCI will follow this only time will tell, but it certainly is in their league as far as pedigree is concerned.

Ashoka Buildcon (AB)

An infrastructure development company, Ashoka Buildcon is engaged in building highways, bridges, power transmission and distribution infrastructure on EPC (engineering, procurement and construction) basis. The government’s thrust on infrastructure and road development projects are key triggers for the industry going forward and will help companies like AB.It has a strong track record, robust order book and well-funded BOT (build-operate-transfer) project portfolio.

With the rains now past, and as work gets going at the two recently appointed hybrid annuity and the recent additions, growth ahead is expected to be healthy. The balance sheet, too, is in shape to ensure growth doesn’t falter for want of funds. Delayed appointed dates, RoW issues for TOT and the monsoon-impacted Q2, made management lower revenue guidance from 25-30% to 20-25%. Margin guidance held at 11-12.5%, but FY20 is expected to be better on strong Q2.

With the lowering of corporate tax, the money saved would flow to the bottom-line, resulting in a huge bump in profits and hence the EPS. Thus the current market price doesn’t factor in the gains from above developments. Analysts are predicting a jump of 50% or more from current price levels if all the above growth factors play out as expected.

Reliance Industries (RI)

This is one giant which has woken up from slumber over the last 2 years, ever since Jio was launched. And this is one elephant which can certainly dance. After going nowhere for the last 5-6 years, all the pieces are falling in place for RI. It has already given a near-40% return in the last 1 year and certainly looks good for the trend to continue.

All the businesses which it had so meticulously nurtured are now flourishing and the result is there for all to see. Of course, deep pockets are always a bonus, but the way Jio disrupted the telecom market is a case study for B-schools. So much so that the Indian telecom market has now become an oligopoly of sorts with only RI and Bharti Airtel still standing and putting up a reasonable fight with Jio. Even a global telecom giant like Vodaphone has fallen by the wayside, in spite of tying up with another Indian stalwart in K.M. Birla.

And Reliance has a few more aces up its sleeve which it will unravel in the years to come and keep its investors in good spirits.

Firstly, it will spin off Jio into a separate digital company a la Alphabet of India. And most of its digital assets including the media and content will probably come under Jio’s banner. It won’t take too much trying to get a strategic investor into this to take care of futurefunding needs and growth.

Second ace up RI’s sleeve is its Retail business. Here too, it could very well turn out to be an Indian Amazon. Right now they are into brick-and-mortar shops in Retail, but Reliance Digital has an online presence and it won’t take too much for Retail to join it online, thus giving the Flipkarts and Amazons and such other e-commerce ventures a run for their money in India.

And lastly, monetising some of its refinery business which has now matured is certainly a great move. With another giant like Saudi Aramco by its side, this could be another masterstroke by Reliance.

With such an array of developments in the offing, valuations are not something one needs to look at currently. With a 1-lakh crore market cap and an EBITDA of about Rs 90,000 crore for the current year, there is an excellent margin of safety.

Induction of strategic investor in Reliance Jio and probably the IPO plans getting crystallised either for Jio or for Retail, will spell great news for investors. In fact, the 1-lakh crore market capitalisation can rise to about Rs 12,50,000 crore in the next one year and that translates into a share price of about Rs 1,900+ in the next year.

Camlin Fine Sciences (CFS)

Camlin is a micro-cap with a market capitalisation of only Rs. 925 crore.It is the world’s second largest manufacturer and marketer of food grade antioxidants TBHQ and BHA with plants in Italy, Guatemala (Central America) and China besides India, and subsidiaries in Europe, US, Brazil, China and Mexico which cover most of the global markets.Its product range includes food ingredients like Antox TBHQ, Antox BHA, Sweetener and API like Miconazole Nitrate B.P. / USP, Clotrimazole B.P. / USP, Amlodipine Besilate E.P etc.The other major players in this category which are CFS’ key competitors are Vidhi Specialty Food Ingredients and Dynemic Industries.

CFS has an SEZ facility in Dahej, Gujarat, which is a prime hub for chemical companies. The production of this plant is expected to start from Dec ’19 onwards, trial runs having already commenced, after much delays. The commercialisation of this plant will male CFS the 2^nd largest producer of HQ and Catechol in the world. This plant will come with multiple benefits (compared to its Italy plant) like

1)     10% higher yield

2)     improved product mix (i.e. 60% HQ vs. 45% there)

3)     much lower utilities cost, and

4)     process waste will be sold as by-product (unlike in Italy).

Additionally, the dependency on material from Italy plant will reduce the logistic cost and currency risk meaningfully. Besides this trigger, another factor is that the utilisation in its plants in China and Italy can be improved significantly.

What adds to the attraction is the attention CFS has recently caught. The latest sensational news is that Radhakishan Damani (owner of Avenue Supermart which runs the D-Mart grocery supermarket chain) has taken a fancy.The wily Billionaire has used his trusted investment arm, Bright Star Investments, to make the acquisition. He now holds about 1.5% in the company.This microcap company from the Chemicals sector has already more than doubled in the last few months  on informed buying and now we know who the buyer is. Analysts expect this to go around 50% more even from this level, if all the growth triggers mentioned above play out as expected.

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

This time the performance has been much better than the disastrous Diwali one. And had it not been for the 2 scrips – Everest Industries and Parag Milk Foods, which cracked close to 50%, this portfolio would have done a lot better. Yet, thanks to Amber, this has managed to weather the battering the midcaps and small caps got during the year and did reasonably well in comparison. BSE Midcap and Smallcap indices are down 3% and 6.85%, respectively, for the year.

This is also a reality check on a mid-and-small-cap tilted portfolio. While this category is the fastest gainer, the fall is equally swift. Both the laggards above still have good potential in the years to come. Everest with its focus on building materials and Parag, the only Indian dairy company with branded products after Britannia which has some dairy products but is into multiple other things as well, and hence though a strong competitor in PMF’s products, may not be a fair comparison.

As I have said many times before, equity is a long term game with a holding period of at least 5 years (and much more in the case of mid and small cap stocks), if not more, to get any meaningful compounded returns. So it may not be really fair to compare YoY returns, especially for mid and small cap stocks, but serves as a periodic check as to how the selected companies are performing. This is especially true in current times when a lot of companies of which it was unthinkable to think that something could go wrong, are today in dire straits (DHFL being a prime example, and even Tata Motors, in spite of  the massive backing from Tata group).

 Here’s wishing all investors a very profitable 2020.