Reflections Of An Argumentative Investor

“If I had a world of my own, everything would be nonsense. Nothing would be what it is, because everything would be what it isn’t. And contrary wise, what is, it wouldn’t be. And what it wouldn’t be, it would. You see?”

                                             ― Lewis Carroll, Alice in Wonderland

The Indian stock market has witnessed numerous positive developments this year, the benchmark indices have rallied in a matter of months on the back of a tide of liquidity and optimism about the union government’s astute management of affairs; a stable currency, good macros and a decent economic growth.

However, this has also led to a tug of war between the Bulls and the Bears. Many pundits of stock market reiterate the fact that if one compares the prices with the earnings then the Indian stock market would be the most expensive stock market in the world.

Even the FIIs pulled out in bulk in August and September 2017. However, despite the heavy offloading by the FIIs during these two months, markets remained steady on the back of strong accumulation by the MFs.

Surprisingly, the FIIs have returned to the Indian markets since October. The recently announced recapitalization of the public sector banks has made the investment case for India stronger! Then came the announcement of India faring well in the World Bank’s ease of doing Business index and finally the Moody’s upgradation of India’s sovereign ratings.

However, there are experts who still insist that this bull-run is mystifying (poor earnings, obviously) and there is a lot of junk on offer.

 “Would you tell me, please, which way I ought to go from here?”
“That depends a good deal on where you want to get to Alice”
“I don’t much care where –”
“Then it doesn’t matter which way you go,”
 

                                             ― Lewis Carroll, Alice in Wonderland

Q) Is the Indian market soaring without wings?

Q) Are the Bulls being irrationally exuberant? or are the Bears being overly pessimistic?

Q) Have the DIIs finally emerged as the principal movers and shakers of the Indian stock market?

Q) Is India finally making the shift towards financial assets from physical assets?

Q) If yes, then is this shift backed by enlightenment or pure greed?

Q) Has the fear of losing out sedated our rationality?

Well, one will have to patiently wait for the months to come to find a definite answer.

In the midst of all these developments, I happened to interact with the CEO of a rapidly growing start-up which specializes in thematic investing. The young leader passionately shared his experience and struggles as a trader, investor and then as an entrepreneur in the industry. He expressed that his goal was not to start a business but to solve a problem which he deeply cared about. He was very confident that he was changing something.

He also grilled me on my goal in life, what was I fighting for?

 “Who are You?”
Alice replied: “I-I hardly know, Sir, just at present – at least I know who I was when I got up this morning, but I think I must have been changed several times since then.”                                

                                                               ― Lewis Carroll, Alice in Wonderland

The 58-minutes long interaction that I had with him actually turned out to be quite an experience. He also inspired me to explore thematic investing.

“It’s no use going back to yesterday, because I was a different person then.”

                                                               ― Lewis Carroll, Alice in Wonderland

Our prime minister has unveiled an ambitious set of agendas after being voted to power with an overwhelming  majority. Many of these agendas would see the daylight, unfortunately many would remain as unfulfilled promises.

I have selected five sub-themes which I believe would definitely become a reality and created an investing theme out of it.

Theme: ‘Acche din 2.0′

Sub-themes

  1. Housing for all
  2. Financial inclusion
  3. Making India a global aviation hub
  4. Make in India
  5. Electric vehicle revolution

I have picked these five themes because the government has already taken a lot of concrete measures for achievement of these agendas which clearly shows the government’s intent; Aadhar, Pradhan Mantri Awas Yojana (PMAY), New Civil Aviation Policy, Regional Connectivity Scheme, 2017 (UDAN) etc.

I tried analyzing the companies which would be able to benefit the most out of these five initiatives. I have focused on a couple of important fundamental factors while identifying the companies, one obviously being the macro support, growth prospects, management bandwidth and past track record.

Although I believe that these companies are fundamentally strong and are likely to benefit from the government’s development agenda, but, this article should not be taken as a recommendation. I have simply expressed my views here. Investors are strictly advised to use this information (as food for thought) to build upon their own analysis before taking a decision.

1) Sub-theme: Housing for all

This story has been told and re-told for quite a long time now and the sector is currently facing three major issues:

a) Intense competition due to proliferation of Housing Finance Companies (HFCs).

b) Slowdown in housing projects due to RERA.

c) The expected competition from PSU Banks, especially post recapitalization.

But the opportunity is huge, RERA may have given a short-term jerk to the sector but over the long run, RERA has the potential to infuse the much needed transparency and accountability to clean up the reality sector.

For instance; RERA has a provision wherein the builder of a property will be liable to provide for workmanship for any structural defect in the property for a period of five years!

Hence, RERA is expected to gradually change the way the real estate industry operates in India.

Regarding competition from PSU Banks, one will have to wait and watch how efficiently will the banks use the fresh capital. PSU Banks continue to suffer from political interference, the real reform that is needed is independence, if the fresh capital is used to write-off loans, then it is going to be business as usual.

Stock under this sub-theme: PNB Housing Finance

PNB Housing Finance (PNB) is the 5th largest housing finance company in India in terms of loan book size. It is one of the fastest growing housing finance companies having a diverse product suite offering retail home loans, loans against property, corporate term loans, non-residential property loans, construction finance, and lease rental discounting. It conducts its operations from a network of 66 branches and 18 processing units.

Rationales

  1. Exceptional growth in AUM: PNB’s AUM has witnessed a spectacular CAGR growth of60% over CAGR FY14-FY16. No other competitor has been able to sustain this kind of growth.
  2. Expansion spree: PNB’s IT model is highly scalable. The Company has already gone through the painful process of creating IT infrastructure in place, now expansion is taking place at a very high speed. This fact has been vouched by even Motilal Oswal (MOSL). MOSL is itself present in housing finance space (Aspire Home Finance). Hence even PNB’s competitors are praising its IT infrastructure.
  3. Solid Management Bandwidth: Sanjay Gupta, 23 years of experience in Housing Finance (Served HDFC for 16 years).
  4. Lowest NPA: Its past five years is less than 0.22% which is the lowest in the industry.
  5. Macro support: The union government will build around 6 crore houses, even if we take the cost of one unit as INR5 lacs only, the industry should double (INR30 lac crore). PNB has a very well-diversified borrowing profile with the cost advantage of a AAA rated company (big players such as PNB will become even bigger!).
  6. Carlyle group’s third largest holding: Carlyle group, the global alternative asset manager with over USD160 billion of AUM across 287 investment vehicles has 37.55% stake in PNB. PNB is now the private equity fund’s third biggest holding in any listed company. The group has a very impressive track record. In July 2014, it fully exited its investment in Repco Home Finance. The exit marked a 9x return for the PE investor over a horizon of almost seven years.

 

2) Sub-theme: Financial inclusion

India accounts for ~21% of the world’s unbanked population. According to ICRA estimates, the potential size of microfinance market stands at INR2.8-3.4 trillion and MFIs are expected to grow at ~30% CAGR over FY17-20E.

Stock under this sub-theme: Ujjivan Financial Services

Ujjivan Financial Services (Ujjivan) is 3rd largest micro-finance institution (MFI) in India in terms of loans disbursed. The company operates with a network of 469 branches spread across 24 states and union territories. It has received an in-principle approval for setting up SFB since 2015. Conversion into SFB affords Ujjivan an opportunity to transform its liability franchise and diversify revenue pool across many customer and product segments.

Rationales

  1. Ujjivan’s AUM has witnessed a spectacular CAGR of 54% over the past five years with 60%-70% of loan disbursement in non-cash mode. However, the gross NPAs were less than 0.30% (jumped to 3.7 due to % demonetization). Its net NPA currently stands at 1.38%.
  2. With a richly diversified branch network across 24 states with 450+ branches, Ujjivan is one of the most well-spread MFIs in India.
  3. The management follows a strict policy on loan concentration; none of the 24 states where it has presence contribute more than 16% to its AUM. Such robust risk management policies has helped it in minimizing sectoral concentration risk.
  4. Samit Ghosh, a prolific banking career spanning three decades in India and abroad. 30 years as a banker, having worked with some top banks including HDFC Bank, Standard Chartered Bank in Dubai and Citibank in India, Dubai and Bahrain. Under his leadership, Ujjivan swallowed the bitter pill of demonetization and passed the sudden stress test with flying colors. This further highlights the strength of Ujjivan’s risk management framework.
  5. Ujjivan Small Finance Bank Ltd, a wholly-owned subsidiary of Ujjivan Financial Services Ltd, has been given scheduled bank status by RBI. This status will enhance the market acceptability of the bank in its effort to garner institutional deposits at a competitive price and participate more actively in the inter-bank market. It also opens the door for issuing Certificates of Deposits (CDs), which will be an important source of funding.

3) Sub-theme: Making India a global aviation hub

The Union government has shown a focused approach with a strategic intent. It introduced a more liberal civil aviation policy in 2016. It went ahead relaxed FDI norms in the sector (100% FDI in green field projects). It has recently launched the ambitious Regional connectivity Scheme (UDAN) for Tier 1 & 2 cities. A reduction of excise duty on ATF would be an icing on the cake.

Stock under this sub-theme: InterGlobe Aviation

Interglobe Aviation Limited operates “IndiGo”, India’s largest passenger airline with 40% market share. The company operates on a low-cost carrier (LCC) business model and focuses on the domestic Indian air travel market. IndiGo has one of the largest fleet catering to domestic markets. IndiGo is the only airline in India to be consistently profitable over the past nine years. Market leadership, strong revenue visibility coupled with stellar profitability renders Indigo the best bet in the Indian aviation industry.

Rationales

  1. Robust track record of profitability: Indigo is the only player in the Indian aviation industry to be consistently profitable over the past seven years. The secret of Indigo’s consistent profits lies its consistent focus on reducing costs. It boasts strong cash‐flow generation, balance sheet and liquidity position.
  2. Consistently gaining market share: Indigo has been successful in seizing market share over the past few years. Its domestic market share increased to 40% in June 2017 from 32% in June 2014.
  3. Eyeing Tier 2 and 3 cities for next leg of growth: The next phase of growth in the domestic aviation market will come from tier 2 and 3 cities. The dynamic pricing introduced by the Indian railways has made airways very competitive, hence a lot of demand is expected to be generated from the tier 2 & 3 cities. Indigo too has decided to fly on regional routes. The Company even took the bold step and change its core strategy of maintaining a single-breed aircraft fleet (single type of aircraft saves training and maintenance costs) and announced that it will acquire 50 ATR 42-600 aircraft (smaller aircrafts) to fly on regional routes. With further penetration on the regional routes, the low-cost carrier is expected to outperform industry growth.
  4. Extremely favorable macroeconomic conditions:
    a) The biggest component in the cost structure of the Indian carriers is the air turbine fuel (ATF), it accounts for over 40% of their input costs. The World Bank estimates crude to remain between USD 40- 60 for the next two years, thanks to the U.S shale production and low compliance to the pledged output cuts by non-OPEC members. Till Brent remains under pressure, most low-cost carriers will continue making profits.
    b) The outlook for the Indian aviation industry remains indisputably positive primarily due to the huge untapped potential considering the fact that U.S. and China with a population of 32.6 Crore and 138 Crore generated a passenger traffic of over 82 Crore and 45 Crore, in 2016, respectively.
    c) Another remarkable fact is the demography; a quarter of the Indian population belongs to the age group of 0-15 years, which means that after 15 years, the citizens currently at 0-1 would be 15 years old and the citizens at 15 would be 30 years old.

4) Sub-theme: Make In India

Stock under this sub-theme: Cochin Shipyard

Cochin Shipyard Ltd is the largest public sector shipyard in India in terms of dock capacity. The Company provides both shipbuilding services and ship repair services to defence and non-defence sector and commercial sector. In FY17, shipbuilding and ship repair contributed to 74% and 26% to its total revenues, respectively. The Company is currently building India’s first Indigenous Aircraft Carrier for the Indian Navy.

  1. Leadership in the Indian ship repair market: It is the leader in the Indian ship repair market, with a market share of 39%, which is about twice the market share of the nearest peer (Goa Shipyard). It’s clientele includes Indian Navy, the Indian Coast Guard, Shipping Corporation of India, ONGC etc. It has also exported over 45 ships to various commercial clients overseas such as the Clipper Group (Bahamas), NPCC, Vroon Offshore (Netherlands) etc.
  2. Stellar track record of profitability: Cochin shipyard holds the distinction of being the only profitable company among its Indian peers. Its revenue and PAT grew at CAGR of 11% and 19% respectively, over the past decade. Its operating margin has expanded from 7.9% in FY07 to 18.4% in FY17. Ship repair business has two times margins than ship building! Its ship repair revenues have jumped from INR196 crore in FY15 to INR375 crore in FY16 to INR550 crore in FY17.
  3. Negligible debt on the books: Cochin Shipyard’s liquidity position is top-notch with negligible debt of around INR228 crore. It reported a cash & equivalent of around INR2,000 crore in FY2017.
  4. New International Ship Repair Facility: This is an INR970 crore project approved by the Union government in May 2016. Under this project, Cochin Shipyard  will set up a ship lift system of size 130 m x 25 m with lifting capacity of 6000 tonnes and 6 workstations. The most remarkable thing here is the fact that this facility would be able to repair up to 85 vessels, which is 2x its current capacity! Hence, this international facility would not only increase the revenues but it will also expand its margins significantly (since the margins in ship repair is 2x of ship building business). 
  5. Strong revenue visibility till 2022: Cochin shipyard has a healthy order book of around INR3000 Crore which is 1.5 times is FY17 revenues. The Company is most likely (emphasis added) to bag the order for phase III of the Indigenous Aircraft Carrier, which is likely to be around INR11,000 crore!

5) Sub-theme: Electric Vehicle

India has set an ambitious target of having only e-vehicles in India by 2030. The government has a plan to put around 1 million electric 3-wheelers and 10,000 electric city buses on Indian roads by mid-2019. A number of automobile manufacturers such as Tata Motors, Maruti Suzuki, M&M have already bid for the project. To be honest, we don’t know which of these players would be successful in manufacturing an affordable EV (say Sedan) by 2020-21. It’s a bit difficult to predict this. Moreover, sometimes emerging trends do not benefit the companies driving the trend rather the companies supporting the trend make a fortune. For example, e-commerce boom did not benefit e-commerce companies in India (all e-commerce players are loss-making) but logistics companies made a fortune due to the e-commerce boom.

So, we know that e-vehicles will be a reality very soon but we don’t know which auto company would be successful among these. But one thing is for sure that this EV revolution is going to drive up copper (and Nickel) consumption manifold times. 

Copper’s terrific electrical conductivity makes it a critical part of the electric vehicle revolution. According to BHP Billiton Limited, an average sized electric vehicle would require 4x more copper than conventional combustion engine vehicles (around 80kg Vs around 20kg). Copper will be used in batteries, copper rotors (used in electric motors), wiring, and even at charging stations. According to International Copper Association, each EV charger will add 0.7 kg of copper. Fast chargers can add up to 8 kg (yes!) of copper each.

Stock under this sub-theme: Hindustan Copper

Although there are a numbers of players (Hindustan Copper, Vedanta, Hindalco) that one can bet under this theme, Hindustan Copper looks quite attractive.

Monopoly status: India imports over 90% of the Copper it requires. Hindustan Copper is the only copper mining company in the India; a monopoly! This puts it in a better position than the other players.

Quadrupling of capacity: The FY17 annual report of Hindustan Copper says that the company is set to quadruple its capacity to 12.40 million tonnes over the next five years. It reserves stand at about 100x than its annual production! In order to achieve this target, the Company has increased its borrowing limit to INR650 crore. According to ICRA, Hindustan Copper’s borrowing strength lies in its monopolistic status as the only company in India with access to large reserves of copper ore.

Scaling up Nickel production: India imports over 99% of the nickel it requires. Hindustan Copper is also among the few producers of nickel in the country. Nickel will be used in the EV battery segment. Though nickel produced by the company is small part of its total production at present, it has plans to scale it up.

Focus on value added products: Hindustan Copper is currently exploring opportunities in value-added products. The management has signed an MOU for a JV with  defense PSU MIDHANI for production of cupronickel alloy tubes. This is a high value-added product that is used extensively in naval fighter ships and submarines. Currently, these tubes are entirely imported into the country. The finalization of this deal could be the next trigger.

Change of guard: In September 2017, Hindustan Copper appointed Santosh Sharma as its new chairman and managing director. He is targeting INR5000 crore turnover in 2019-20 with better profitability and asset utilisation. He also has a target of bagging the Navaratna status by 2022-23.

Hindustan Copper can become another Hindustan Zinc~ Anil Agarwal, Chairman,Vedanta Resources

Privatization on the cards?

In August 2017, the union government dis-invested 6.83% stake in Hindustan Copper to raise around INR400 crore, the stock zoomed about 50% in just five trading sessions! Recently, Mr. Santosh Sharma, the new Chairman and MD has hinted that the Company may go for further stake sales to meet its expansion plans. Any future stake sale will definitely unlock tremendous value for the investors.

 

Risks associated with ‘Acche din 2.0’:

1) This theme (to some extent) suffers from the ‘Key man risk’. I have assumed that Narendra Modi will be able to come back to power in the 2019 and hence, his policies and initiatives will continue as expected.

2) Although the Indian defence industry is at an inflection point in its expansion cycle backed by the government’s clear vision for an indigenous defence industry, Cochin Shipyard’s high dependence on defence sector coupled with the cyclical nature of commercial ship-building is seen as key risks associated with its business.

3) Although Hindustan Copper has set an ambitious target, when it comes to achieving targets, PSUs have poor track records!

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