Answers to doubts and fears that prevent you from investing now when prices are attractive!

What is the NBFC Problem? What is the government doing to contain the issues? Is Auto Slowdown very severe? Why has equity not delivered good returns yet?
Here’s a list of questions that investors want answers to in today’s context:

1. Why is the government not doing enough to arrest the slowdown?
2. Why does the government look to divest so aggressively?
3. How grave is an NBFC problem? Can it lead to contagion?
4. Why are big corporate brands not doing well?
5. Why is the Auto sector slowing down so much? How long will it last?
6. Yes Bank is making headlines for wrong reasons. How grave is the impact?
7. Now that we have addressed India’s problem what if US slows down?
8. Why has India not generated 15% equity returns in the last 10 years?
9. Are prices/market really at attractive levels to make investments?
10. What do I do with the stocks in my portfolio that have already corrected?

Why is the government not doing enough to arrest the slowdown?

Most of the government reforms are long term in nature for obvious reasons. It can’t fuel short term growth as it has limited tools to do that. It has made large commitment to PSU recapitalization which will get PSU banks to start lending again (PSU still have 65% market share, though declining it’s significant). The government has been expanding road network and infrastructure like metro, affordable housing which is generating new employment, but yet to add in consumption growth.

In rural areas, the government has made many sustainable sources of income instead of a one-time bounty of farm loan waivers. Creation of water reservoirs in fields, providing minimum support prices, guaranteed income for very poor farmers can create sustainable prosperity in rural areas.

The government is also making compulsory manufacturing Make in India for defence and various retail industries. If not 100%, more than 30% to be sourced within the country can lead to better job creation and income growth. The ripple effects will be felt later.

While we can see just roads, etc. We are overlooking PSU’s growth in capex over time. Our refineries, oil and gas exploration, power generation and power transmission companies are growing at a phenomenal pace. This also adds to employment and wealth creation.

Why does the government look to divest so aggressively?

India’s government has changed from pseudo-socialist to more capitalist. It can’t go from black to white in one shot. Firing government employees can have repercussions. Hence, it has many impending issues like Air India, BSNL, etc.

However, we must look up to the government that allowed competition in sectors like telecom, aviation, banks, power by choice. They may have not given out license to private players and kept all the businesses to themselves. But it chose to improve the productivity of the country by letting private players run the business more efficiently with the pursuit of more profits. This had a natural consequence of PSU becoming obsolete or bankrupt. This was a known risk and outcome of large privatization reforms, but still the government went ahead with it to improve access, better affordability and widespread distribution. If PSU had continued running those businesses, we can’t imagine getting a smartphone, 4G, autos, mobile banking, Flipkart for shopping, Uber for cabs, Swiggy for food delivery, etc.

The bitter truth is the survival of the fittest, from living species to companies. PSU that is not fittest will die so that better ones prosper and create value. Loss-making PSU will cause a huge burden on public finances/tax payers. This has to stop and hence the government’s stance is right we would say.

Divestment in several sectors – India has a very small tax base and the large population doesn’t have the income to pay tax on that. However, to spend on the welfare of its civilians, the government has to identify the source of income. Although it is trying to get more people in the tax base who have been evading till now, this may not be enough to match the government’s expenditure program. Divestment from its own shares is the easy route to generate funds to channelize in the right direction like welfare schemes/infra where profitability might be lower. The government had large divestment in 2003 as well when it sold Balco, VSNL, etc. After that, we had a bull market.

We find that divestment is happening in companies that have a profitable business model and sustainable cash flows which will find many takers like for-profit long term investors like Mutual Funds and Sovereign funds. Since most PSUs cater to the infra/capex side of the economy, the last few years of slowdown in that segment have led to poor stock performance. We believe that profitable PSU shares will come back once the capex cycle picks up. In a period from 2000-2010, PSU was one of the best performers and it had several multi-baggers. BHEL, Bharat Electronics, Engineers India, Balmer Lawrie, SBI, MMTC, ONGC, IOCL, etc. Of course, many of these are not relevant now but many new PSUs have got listed that have a good business model.

How grave is an NBFC problem? Can it lead to contagion?

NBFC source the funds from the market and do not have access to low-cost saving and current accounts. Because their cost of funds is high, they lend to riskier pockets wherein they can charge a higher interest rate. Hence their asset quality is going to be lower than good banks. Now that the economy is facing a liquidity crisis, the asset quality is coming out. Because of cautious stance, the banks have stopped lending to NBFCs which led to a slowdown in some well-run companies too. Doesn’t that mean that this will lead to an economic slowdown? Definitely NO! This is not the first time the NBFC crisis has hit the market. In 1998, more than half the NBFCs have shut shops. In 2008, many NBFC faced problems and went under, taken over. This too shall pass as worst come outs. We do not believe that anything new has happened on this front. It is not insurmountable given the government and RBI has enough experience to deal with it.

“We are monitoring NBFCs based on their size and based on their past repayment behavior… We are monitoring their operations very closely and at regular intervals,” RBI governor Shaktikanta Das said after the customary post-budget board meeting addressed by finance minister Nirmala Sitharaman in the capital.

In an interview with Business Standard, Das said the RBI was monitoring and scrutinizing the top 50, and had a “good understanding of what are the numbers and cash flows of these firms”. “I think the credit flow (to the NBFC sector) will gather greater momentum very soon,” he said.

Why are big corporate brands not doing well?

We had highlighted that corporates weren’t growing at a good pace for the last many years. It is only now that stock prices are falling everyone is noticing a fall in growth rates. Refer our blog February 2019: MoneyWorks4me Outlook

The risk-averse nature of banks has led to poor financing of dealers/distributors. If we see growth numbers for Asian Paints, Berger who don’t employ large distributors in their supply chain is able to grow as they direct supply goods to dealers based on demand. Some slowdown has to do with dealers/distributors who were not ready for GST and facing problems to scale up. The large companies in the supply chain will help them make the business model viable.

Yes Bank is making headlines for wrong reasons. How grave is the impact?

This is not the first time that a bank is facing a crisis. GTB, Centurion Bank of Punjab and Times Bank had seen worse situations than this. Even much bigger banks like SBI, ICICI Bank stock earned 0% CAGR over a 10 year period. These were much larger banks with multiple stakeholders. Even their negatives didn’t derail overall market return. We do not believe that one bank’s bad underwriting practices can derail market sentiment. We have always warned our subscribers to stay away from Yes Bank. Even if you did have investment, we believe in a diversified portfolio, the impact of some duds is quite limited.

Why is the Auto sector slowing down so much? How long will it last?

While Media is going overboard on reporting the sad state of Auto, Autos has always been cyclical. We do not see the slowdown as structural. Current steep cuts in volumes are due to financing issues from NBFCs as NBFCs funded 30% of the auto sales. We believe that this slack can be picked up by large banks over time. Auto companies will find a way to tie up with these financiers.

The current hike in prices of autos from BSVI to road taxes may be adding fuel to the fire. This is something where the government may choose to relax GST for some years so that consumers don’t feel the pinch of transitioning to better fuel technology. Again the GST cut demanded by the Auto industry is not the first time to get auto demand back. In 2001, 2009 and 2014, the government has cut excise duty and slowdown stopped post that. We have usually seen 6-8 quarters of a slowdown in the past in 2w and 4w. Maximum it may last 10-12 quarters. CVs typically have longer/deeper cycles.

For those who are worried about EV, we find that EV is still unaffordable for the average joe in the country. The government is keen to grow market share for EV along with IC engines Autos, otherwise, why would PSU exploration & refineries take up large capex year after year.

Even if the government makes EV compulsory if the auto companies can’t sell enough high priced electric vehicles, why would they continue the business while continuing to run losses? We find that the government wants CNG, Petrol and EV to co-exist. Besides, the EV will not be feasible for all segments of autos. Only a few which can afford or pollute the most will first get upgraded to EV. Our reading is that public transportation, commercial transport like Auto Rickshaw will first see mass EV transition. The rest of the segments will see electric vehicles only in select urban areas up to certain % of total volumes.

Now that we have addressed India’s problem what if US slows down?

Unlike in China, we are very lucky to have just 15-18% of our GDP from exports. Most of our GDP comes from India’s infrastructure investment and consumption spends. This makes a relatively aloof from what happens in US. Besides, the exports we make to US are on lower their cost of service. So with slowdown on cards, they will not give up on low-cost procurement like IT services and pharmaceutical products. So even if growth rates can moderate due to US slowdown, the base business of our exports will remain intact.

It is only the short term stock price movement happen in tandem, over 10 years, there is a large disparity between India’s and US stock market returns. All in INR terms.

Period 2000- 2010 : India 15% CAGR; US 0% CAGR

Period 2009-2019 : India 10% CAGR; US 15% CAGR

We can say that although US was doing well, India didn’t fare well in the last decade. Similarly, when US stocks went nowhere from 2000 -2010 India earned a respectable 15% CAGR (just on index level)

We recommend our investors to invest in stocks outside the country as well. However, today is not the right time to add to developed market equity as they trade at near peak business activity.

Why has India not generated 15% equity returns in the last 10 years?

Equity’s prospects are dependent on India’s business prospects. If a business doesn’t flourish, even equity wouldn’t. Although we follow value investing, it’s not possible to grow the portfolio very fast when underlying businesses are not growing fast. We must agree to the fact that equity doesn’t provide a guaranteed return. It can earn as high as 18% CAGR in a decade or just a 7% CAGR. Growing money at 7%  CAGR in the worst case, with optionality to earn 18% CAGR if everything is a very good risk-reward scenario. We have seen the more probable return number we will see is in the range of 12-15% CAGR. The risk in equity, as highlighted popularly, is not volatility. The risk inequity is not meeting our desired return or not in the desired time. Hence, we recommend prudence and diversification across asset classes. We have taken care of equity risk by having multiple assets in the portfolio.

Repo Rate cut: Banks are not profitable to lend at a lower rate as their cost of funds has been high due to the high small savings rate by the government in PPF, NSC, etc. To attract more deposits, Banks have to assure similar or very close to that rate on its deposits. After borrowing from depositors at such high rates, they can’t lend at lower rates in lines with repo rate + few basis points. We have seen recently banks transmitting lower interest rates as RBI’s cut repo rate aggressively.

Real estate: Real estate boom led many not so good developers to believe that they can also mint money. This led to either surplus in select areas or profitability crunch in others. Supply and demand keep happening from time to time. Just like in our societies there will be many Chola Kulcha, Gol Gappa hawkers as soon as one or two become famous. But that doesn’t mean all will stay in business. A few will die as demand is less than supply.

India’s position in world GDP: Although it’s good to be competitive and aim for beating many countries in size of GDP but we believe India is under no pressure to compete with anyone. It has its own problems and some of its advantages. It will grow at its pace based on what industries flourish in the country.

Industries, where a lot of patent/technology is required, will come from outside but services and manufacturing can happen in India. We can’t have dominance in all sectors as it depends on available resources/skills/Culture. Our culture doesn’t allow failures leading to a lesser number of people taking up the risk of innovation but rather find comfort in mimicking business models like Flipkart, Ola, etc. We can’t overcome such shortcomings completely. However, if that is happening in an efficient manner, there is a lot of value that will get added.

Are prices/market really at attractive levels to make investments?

Top 15 stocks of Nifty 50 have appreciated a lot in the last 2 years. While the rest of the Nifty has fallen around 15-20%. We believe that many pockets have corrected their lowest valuation metric. We believe that instead of waiting for the bottom, we buy selectively where we find value and sit tight.

Upside potential on Nifty has improved from 7% to 11% CAGR on the base case scenario. Within that, we find that many not so good quality stocks are traded very cheaply. Our universe of quality companies still shows a 9% CAGR upside over 3 years. Within that, we find around 10-15 good companies that are worth investing immediately.

What do I do with the stocks in my portfolio that have already corrected?

If you have bought stocks on recommendations of MoneyWorks4me, you do not have to worry about fall from the purchase price. We buy prices at prices with an expectation earning of 15% CAGR over 3 year period. We can’t pick an exact bottom in stock prices but we can only buy when the upside is more than our desired rate of return.

If you haven’t bought stocks on MoneyWorks4me recommendations, you can use our color codes and upside potential tool on individual stocks to identify which stocks are bad quality and provide lower upside potential. This will help you get rid of not so good opportunities and get into better ones.

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