Diwali Dhamaka 2022

Here’s wishing everyone a great Diwali and a prosperous new year ahead. After the recovery seen since last Diwali, the market appears to continue being volatile, mainly driven by what’s happening globally rather any India-specific problem. COVID, for all practical purposes, is now done and dusted, and people have gone back to their old pre-COVID lives. There are occasional noises being made by medical professionals here and there, but they are largely taken in stride globally, with nobody getting unduly worried.

The major global event which happened this year and shook the world is the unexpected Russian invasion of Ukraine, and there seems to be no sign of it ending anytime soon. And it has had a domino effect on the global economy. The key commodity which the Russians have is Oil and it is this that they have held Europe hostage to. The gas disruption caused by the Russian stoppage has shaken European economy and it will be some years after the war ends, that it is likely to become normal. And this also has impacted US, a major European trade partner. When all this will end, only time will tell.

The other thing which stands out this time is the resilience the Indian market is showing in the volatile global environment. While the US and European markets have crashed big time, not so the Indian markets. They have taken an occasional knock, but have bounced back soon enough.

The year ahead therefore holds a lot of promise for the Indian economy and consequently the markets. The Indian consumption story led by attractive demographics continues to be strong, and it is these sectors that are likely to stand out compared to the new age businesses of the last 2 years which were the seasonal flavour then. And these new age businesses, and their investors, have woken up to the ground realities with most of them losing 75% of the valuations at which they listed on the Indian stock exchanges.

While Pharma was the flavour during Diwali 2020 and PSUs last year due to the divestment fervour, which eventually didn’t materialize, this year it should be the Consumption story playing out. The other sector which has largely been ignored over the last few years and is poised for a comeback is the Autos and ancillaries which have turned attractive now. Though IT is a secular play with the currency tailwinds behind it, the valuations of most of the top large cap stocks have run up and only the niche ones (mostly in the mid and small cap space) are likely to survive this period and come out stronger. The major themes that I will therefore focus on this time are Consumption and related sectors.

Lemon Tree Hotels (LTH)

India, for long didn’t have any hotel chain culture existing, apart from the Taj and Oberoi groups. And these were mostly restricted to the 5-star category. But with the booming travel and tourism market, Revenge Tourism as it has been coined by the media, some industry veterans have put their heads together and come out with a chain of hotels pan India, and not the 5-star ones but catering to India’s booming middle class. Last 2 years were a double whammy for these chains as the pandemic and ensuing lockdowns ensured that people didn’t travel or go out anywhere either for business, leisure or vacations. And the only ones who have survived this period are the ones to bet on as the lessons learned during these 2 years will be life lessons for them and they should capitalize on the opportunities ahead. Most of the unorganized single hotel types have closed down in this period and the organized ones are having a field day.

Despite global economy reeling under the heat of slowdown and inflation concern, hotel stocks in India have delivered stellar return to their investors in recent times. In year-to-date (YTD) time, Indian Hotels Company shares have risen 80%, EIH shot up around 50% while LTH too ascended to the tune of 80%. As festive season has begun and it is expected to last till end of this year, there is still steam left in these.

One such chain which has caught my attention is Lemon Tree. I have personally been to some of these and the experience has been great. Tata also tried to get into the budget and mid-market segment with their Ginger and Vivanta brands, but they are yet to make their mark. Same is the case with Royal Orchid.

The favourable location of LTH's properties in prominent business and tourist districts supports revenue growth prospects and reduces concentration risk. With the opening of international borders to foreign tourists, the hotel business in key cities like Mumbai and Delhi is set to improve significantly and Lemon Tree is likely to be the key beneficiary.

Promoted by Patanjali Keswani, LTH is the largest hotel chain in the mid-priced segment in India. It operates 8,497 rooms in 86 hotels across 54 destinations in India and abroad under brands like Aurika (premium), Lemon Tree premier, Lemon Tree (Midscale), RedFox (Economy) and Keys (Prima, Select and Lite). Of its 86 hotels in its portfolio, 40 are owned or leased and the rest 46 are managed or franchised.

The company is well positioned to capture the unorganised market share due to slowdown in the upcoming room supply in the wake of ongoing distress in smaller and unorganized hotels segment. The company’s large asset base, strategic partnerships and financial flexibility would continue to support the liquidity profile, if further need arises.

Currently quoting around 84, the company can easily give returns upwards of 30% conservatively over the next year or 2 and then can go the Indian Hotels way, if things go as they have planned. The risk here is that due to the hit in the previous 2 financial years, it is still in the Red but improving fast. So conventional financial parameters like PE ratio are not relevant here. So the initial buoyancy may go towards coming in black and then growing from there on, assuming no major shocks like the COVID pandemic.

The company is well-positioned to capture the unorganised market share due to a slowdown in upcoming room supply in the wake of ongoing distress. This is a potential compounding play on India’s consumption story in the travel & tourism sector, starved as it is of quality hotel chains, a gap which LTH is seeking to fill.

Devyani International (DI)

This is another classic beneficiary of India’s ballooning demographic-led consumption story. DI went public last Aug (2021) at an issue price of 90 and has already more than doubled over the last year, another sign that consumption has not really been as much impacted as some of the other sectors of Indian economy and continues to hold promise.

Incorporated in 1991, DI is the largest franchisee of Yum Brands and among the largest quick-service restaurants (QSR) chain operators in India with 655 stores across 155 cities all over the country. Yum Brands Inc. operates many fast food brands i.e. Pizza Hut, KFC, and Taco Bell brands. It operates 3 business verticals;

1. Core Brands (KFC, Pizza Hut, and Costa Coffee stores in India)

2. International Business (stores in foreign countries i.e. Nepal and Nigeria), and

3. Other Businesses (own branded stores i.e. Vaango, Food Street, Masala Twist, Ile Bar, Amreli, and Ckrussh Juice Bar).

Initially, the business started with a Pizza Hut store in Jaipur but subsequently expanded operations in both KFC and Pizza hut, and operates 264 KFC stores, 297 Pizza Hut stores, and 44 Costa Coffee stores in India. The biggest advantage of DI is its band strength which cuts across all age groups. The promoter, Ravi Jaipuria is a seasoned hospitality industry and chairman of RJ Corp which apart from DI also runs Varun Beverages, the second-largest bottling partner for PepsiCo's soft drink brands outside the US. Thus there are obvious synergies in both businesses of RJ Corp thus benefitting both. DI runs several brands which are a big hit among the younger generation as well as millennials, which makes it quite diversified. This also reduces risks and increases growth potential.

The company has been able to do expansion even amid the Covid-19 times. To counter the effects of COVID-19, the company adopted the approach of re-developing its menus to focus on delivery and takeaway options. DI also introduced measures to reduce fixed and variable costs and sought rental waivers from store landlords and lessors. It also rationalized certain loss-making stores to maintain profitability and strong operating financial performance, though it is yet to come out of red.

Its closest listed competitors are Jubilant Foodworks (Dominos), Westlife Development (McDonalds) and Burger King. However, Westlife Development and Burger King are single product (burger) companies while Jubilant is primarily a Pizza company, though it is making some attempts at diversification. And this is where DI scores with its multiple brands spanning different product types (KFC-Burgers, Pizza Hut – Pizzas, Costa Coffee – beverages & bakery).

As can be seen in recent months, the re-opening theme is here to stay for some time and Westlife (McDonalds) which has been around for some time now, has been a big beneficiary in the stock market with its stock price nearly doubling in the last 2 years. The same may very well play out with DI. RJ’s golden touch (as with Varun Beverages) is likely to help make this faster. Currently quoting around 190, this could be another steady compounding story over the next few years.

Associated Alcohols & Breweries (AAB)

This is not a branded play on the liquor market but a contract manufacturer. It is also into grain-based ethanol manufacturing which could well be the next big trigger for it along with the current consumption boom.

This contract manufactures for the liquor MNC United Spirits (US) with best selling brands like Black Dog, Smirnoff Vodka and VAT69 among others. United Spirits has had a stellar run in the last 2 years from 550-600 levels to more than 800 now. Naturally, AAB will be a big beneficiary of US’ stellar run and more so with the festive season and arrival of foreign tourists who are the biggest consumers of these global brands. And that’s not all. In addition to contract manufacturing, AAB also has around 7 of its own spirit brands which are marketed in 5 states locally and are quite popular there.

Recently AAB has recently completed its capacity expansion the results of which will start coming from the current quarter. This is likely to have a positive impact on its sales, margins as well as the bottom-line. And the best part is that even without this rub-off, it is quoting at attractive valuations. With a Mcap of just about 850 Cr, it is a true Microcap. And that’s where money is made.

In spite of the expansion it undertook, AAB is a debt-free company. And this in itself is no mean achievement. Not only that, it is currently quoting at a PE of 13 while most popular liquor stocks (Radico Khaitan, US etc.) quote at PEs from 18-30. And this ratio will further come down with the increase in its numbers in the next few quarters once its expansion effect comes into play. So the price will have to rise to catch up with the sector PE. And conservatively, this can be at least 50% from the current level. With debt-free status, which in itself is commendable in current times, the increase in its bottom-line will straight go into its EPS

Another interesting aspect is AAB’s focus on increasing its own brands. Recently US divested some of its popular brands to focus on its premium offerings and AAB bought some of these 32 on royalty basis from them. This IMFL foray, where they themselves will manufacture these brands as well as sell them (earlier US used to sell them under its own banner) will further enhance AAB’S margins. This is a kind of forward integration that they have undertaken.

Liquor sector is set for a re-rating in the next few years with even retail stores being allowed to vend them eventually a la 7-11 in USA. So it is imperative to have a few of these stocks in one’s core portfolio from this sector and there is a wide variety to choose from – US, UB, Radico Khaitan and few others.

With all this in place, AAB should go on to give strong compounding over the next few years.Currently it quotes at around 470 and has the potential to double over the next 2-3 years with strong tailwinds.

L&T Technology Services (LTTS)

LTTS provides services and solutions in the areas of product software, mechanical and manufacturing engineering, embedded systems, engineering analytics and plant engineering. The Company operates through five segments: Transportation, Telecom & Hi Tech, Industrial Products, Plant Engineering and Medical Devices.

LTTS has a strong presence in the different verticals and a higher geographical presence. This reduces the dependency on one particular sector, making the business more robust and having better sustainability. The strong client relationship indicates the robustness of the business. It has strong patents and strong digital capabilities to capitalize on the demand as compared to peers across geographies.

LTTS undertakes complex design and engineering projects that require deep domain expertise. They operate higher up the value chain thereby making higher margins on the services offered.

While attrition has been a headache for most IT companies over the last few months, niche firms such as LTTS are less likely to be impacted as the employees here have niche skills and there are limited opportunities for these, compared to plain vanilla IT services skill set. Key engineering problems are best solved by companies such as LTTS and not plain vanilla IT services firms though each of the majors has a small segment working in these areas. However, the contribution of this segment to the overall company is negligible for the bug 5 IT services firms. Companies across the globe spent US$1.5 tn on ER&D in 2020. Global ER&D spend is expected to shoot up to US$ 2.6 tn by 2026.

Given a strong parentage in the largest Indian engg. company L&T and its global reach, LTTS is well poised to grow steadily in the coming years. Compared to its nearest competitor Tata Elxsi (TE), LTTS has better diversified revenue mix and is way cheaper than TE.

Given the rupee depreciation. focus on niche IT areas of engineering R&D and product development, LTTS has great prospects going ahead. Due to the turmoil in the US, it has taken a beating from where it was last year (~6000) and thus provides a good entry point at 3500 now.

Nifty Auto ETF

If the vehicle sales figures published in the last 2 days are anything to go by, happy days are here again for the Auto sector. This was one sector which was battered over the last few years and its woes compounded in the last 2 years due to the supply chain disruption following the COVID pandemic. While things are not fully normal yet, there are green shoots emerging and hence this is the right time to stock up on this sector.

COVID pandemic also brought to the fore the primary need for self and safe mobility and there was a rush for cars of all sizes from last year once there were signs of the pandemic stabilizing, which unfortunately couldn’t be fulfilled. The same was the case with 2-wheelers. Add to that the headwinds of chip shortage, and other auto ancillaries primarily from China, and there is a huge pent-up demand waiting to be met. And the industry appears to be gearing up for it with a slew of launches planned in the next few months/years. And with the advent of EVs, both 4-wheelers and 2-wheelers are gearing up for good time ahead.

The Auto sector is at the cusp of a turnaround with a return to normalcy post-COVID already underway. Valuations are at a discount to long term averages unlike other sectors (4.4 times P/B vs 10 year average of 5 times). Margins and return ratios are expected to improve significantly in an expected cyclical recovery, after taking a beating in the down-cycle in the past few years. Opening up of workplaces and educational institutes will also aid revival of transportation segments (e.g. 3Ws/buses/scooters).

While the major listed players – Maruti Suzuki, M&M, Tata Motors, Eicher Motors and Escorts (post its takeover by the Japanese player Kubota), are all good plays, an Auto ETF will be a much more promising bet which can give all the good things in 1 neat packet. Currently there are 2 such ETFs being run - by ICICI Prudential AMC & Nippon India AMC. Being an ETF, there is very little to choose form between the 2, so you can take your pick based on individual preferences. Though small (93 Cr.), ICICI Pru has more than double the AUM of Nippon AMC's ETF.

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

	2021	2022	Difference	Gain/Loss
Rane Holdings	633.15	912.80	279.65	44.17%
HDFC	2899.95	2355.35	-544.60	-18.78%
Tata Power	231.35	218.60	-12.75	-5.51%
Max Healthcare Institute	345.65	411.00	65.35	18.91%
Sterling & Wilson Renewable Energy	448.80	295.20	-153.60	-34.22%
	4558.90	4192.95	-365.95	-8.03%

 

The overall return of -8.03% can’t be considered good by any yardstick. Apart from the lone Auto sector representative Rane Holdings, and to some extent Max Healthcare Institute, none of the others have really done justice to their potential amid the volatile market in the last 1 year. However, they had already run up quite a bit by last Diwali and have paused in their upward journey. All these are fundamentally sound stocks and can continue to grow and provide good returns over the next few years.

The current picks are a bet on India’s Consumption story and have the potential to generate compounding returns over the next few years, and not just next Diwali. You may not get market-beating returns every year, but can surely expect steady compounding (probably market-beating) over a longer timeframe.

HAPPY MUHURAT TRADING!!