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04 Jul 2020 by Jigna Shah
Monthly Newsletter - June 2020 -Research & Ranking

India continues to be in the center of the storm. It is a combination of once in a century medical crisis and once in a decade financial market crisis. Even though the Covid-19 cases, continue to surge, resilient India has opened up business activities in a phased manner challenging this invisible micro-organism. And this should help in moving the wheels of the economy.

Currently, major industrial cities like Mumbai, Delhi, Chennai, and Ahmedabad contributing over 40% of all India are under red zone which is likely to delay recovery. What's good is that post the all India Unlock 1.0 program, we are now starting to implement Unlock 2.0 in many affected states.

After a kneejerk March (-23%) and bouncy Apr (+15%), Nifty saw reduced volatility and positive momentum in May (-3%) and June (+8%). This makes it -15% from Jan’20 till 30th June as compared to -11% for Dow Jones, -6% for S&P 500, -19% for FTSE, -22% for RTS Index. Sectors in the essential and semi-essential catering like FMCG, Telecom, Agri, pharma are doing better than those catering to discretionary like hotels, entertainment, aviation, real estate.

What is clear is that every sector and every company will be impacted by Covid-19 crisis, the difference is the quantum of impact: 10%, 20%, 40% or more. Thus, FY21 will see negative GDP growth (anywhere between 3% and 6%) first time after 40 years. Other countries are also in the same boat. As per IMF, the global economy is expected to contract 4.9% in 2020: advanced economies by 8%, emerging markets by 3%; the bounce back in 2021 is also likely to be sharp: 5.4%, 4.8% and 5.9% respectively.

KEY EVENTS DURING MONTH OF JUNE 2020

  • Border tensions between India and China escalated with troops on both sides suffering casualties
  • Government reply to China's coercive moves through tactical moves like making the printing of country of origin mandatory on imported products, giving preference to India made products & also giving preference to Indian agencies in government contracts and banning 59 Chinese apps notably TikTok.
  • India entered the list of top 4 countries hit by coronavirus as confirmed cases rose to +6 lakh, but total cases and deaths as a percentage of the population remained much lower than other severely affected countries
  • GST collections in June was at Rs. 90,917 crores (down just 9% YOY) as compared to the average of around Rs. 100,000 crores per month pre-Covid, Rs. 32,294 crores in April, and Rs. 62,009 crores in May.
  • FIIs and DIIs were net buyers during the second consecutive month after heavy selling in March and April.

In this dark, there are few silver linings like:

  • Rural India is currently blossoming- area under cultivation is presently more than twice that in the same period last year; good Rabi harvesting has been followed by a good Kharif sowing. We should see the third consecutive year of above average rainfall: rainfall in June 2020 was higher than average, more so in West, Central & South.
  • Britannia Industries and some other FMCG & pharma companies are estimated to have grown sales 10-20% in 1QFY21.
  • Core growth has started to improve and should continue going forward: May saw 23% YOY decline vs 37% dip in Apr '20. Steel production was down 48% in May vs 87% in Apr, power down 16% in May vs 22% in Apr. June is expected to be better than May, and likewise, the situation is expected to improve month-on-month over the coming months until we return to normalcy. Overall business outlook, as measured by composite PMI Index (combination of services and manufacturing output), was at 38 vs 15 in May and thus inching closer to 50 which was there pre crisis.
  • Demand for quality secondary and primary offerings as reflected in successful offerings by RIL / HUL / HDFC Life / Bharti Airtel/ Kotak Bank. MSCI & FTSE has proposed to increase India's weight in EM indices over the coming months. This can get an additional $3-7 billion FPI flows in Indian equities.
  • Lower Oil prices - down 35% from Jan'20 levels result in savings of $35bn (1% of GDP)
  • The lower trade deficit with China, due to the boycott of Chinese goods and trade surplus in FY21 caused due to lower import of gold, crude, electronics etc.

WHAT ARE WE HEARING/READING KEY EVENTS DURING MONTH OF JUNE 2020?

The on-ground activity seems to be normalizing in June faster than expected. Our channel checks and on-ground readings suggest:

Category/company

Vs pre-Covid levels *

2-Wheeler- Rural/Urban

75%/65%

4-Wheeler/ Tractors

50%/100%

FMCG- Rural/Urban

85%/70%

Innerwear

80%-90%

Organised Jewellery

50%-60%

Banking credit

95%-100%

Insurance (Life & General) and Mutual Fund Inv.

70%-75%

Paints

70%-80%

Consumer Durables

60%-70%

Cement/ Steel

85%/75%

*If sales were 100 units pre Covid (Jan/Feb), then current sales is 75 units or 85 units as case may be.

Thus, it may not be a bold statement to make that bottom of the market is behind us.

What will lend support is the $10 trillion global stimulus packages, advancement in research on vaccine, cure and markets/people looking beyond pandemic (not fretting as much as in Mar/Apr). Market cap to GDP ratio currently at 62 % is at the lower end of the range: 60%-90%. We expect Nifty consolidating in the range of 9,500-10,500 in the near term and then move to 11,000-12,000 post Nov'20. We believe investors should consider investing half of their investment now with the balance half in a staggered manner over the coming 3-6 months depending on advancement towards availability of a vaccine and business return to normalcy.

For a detailed assessment, we had recorded a webinar a couple of days back. You can view the same here.

 KEY UPCOMING EVENTS

Events in the coming months that will provide swings to the markets are:

  • 1QFY21 results – Given it's a washout, more than P&L, markets would be focusing on balance sheet resilience and sales trend seen in July & August.
  • US Presidential election (Nov'20) - Mr Trump's re-election will be good for US stock markets and in turn for many developing economies like India.
  • The state election in India (Bihar) in November 2020 –The ruling party at Centre & state would have to avoid significant reforms which could derail the economy again and instead focus on measures which will enhance domestic consumption.

 Best practices for Wealth creation

  • Rather than waiting on the sidelines or adopting a wait and watch approach, start accumulating good stocks in a staggered manner, all the positives that are being ignored currently will contribute in a sustainable market rally, as soon as the coronavirus related scare peaks out.
  • Avoid getting distracted from information overload/ distraction/rumours via forwards on WhatsApp/Twitter/news channels.
  • Don't try to time by selling fundamentally strong stocks from your portfolio now and try to re-enter at lower levels later.
  • Keep a horizon of 3-5 years while investing in good businesses and invest only that portion of corpus that you wouldn't need over next 3-5 yrs. While this may sound like a cliché, its importance can never be overstated.

Always remember, our country of 1.37 billion people is vastly under-penetrated in most aspects vis-à-vis developed countries. History has shown us that crisis when combined with above point creates ample multi-year opportunities for growth and wealth creation, provided you've invested your money in the right hands.

FOOD FOR THOUGHT

The intrinsic value of a business and how does it change and adapt itself to any crisis.

Through this article, we are trying to understand the gap between the damage to the value of a business on account of a crisis and the fall in its stock price.

Warren Buffett's professor, Benjamin Graham, had founded the concept of Mr. Market in the 1940s, to describe the irrational traits of investors. He described Mr. Market as an investor prone to erratic swings of pessimism and optimism. Since the majority of the stock market is comprised of such investors, he felt that the market as a whole take on these characteristics. His advice was that while Mr. Market creates ups and downs in stock prices all the time, prudent fundamental investors should remain unfazed by these and keep looking at the larger, long-term picture.

Not much has changed over the past few decades as investors continue to exhibit the same behaviour. Once in a decade or thereabout, we witness a plummeting of stock prices based on perceived risk to the economy and its growth. It is during such times that value investors encash the opportunity by buying stocks where the gap between intrinsic value and current trading price widens significantly.

Intrinsic Value

It is the present value of the cash flows that the business will generate through its life. We break it into two parts; the first twenty years and then beyond these twenty years. Businesses are going concerns, and well-managed business is expected to be around for a very long time, 40 years, 50 years, 60 years or even more. It is for this reason that we need to ascribe a value to businesses beyond the first twenty years, which can be called as the perpetual value of the business.

  • Perpetual Value: Typically, the range of perpetual value for various businesses across industries is between 22% and 45% of the total intrinsic value of these businesses. So, we can take 33% as an average. With the assumption that the business is resilient enough to survive all kinds of crisis, including likes of Global Financial crisis, current Covid crisis, the perpetual value of such business will not be impacted.
  • First 20 years: The remaining 67% of the value of the business is being derived from the present value of cash flows generated during the first 20 years of the life of the business.

Conclusion: The intrinsic value of the business is derived by multiplying 100 (NPV of future cash flows) with 30 (multiplier), which is Rs. 3,000, which is the value of the business pre-crisis. We have scenario analysis of if a crisis hits the economy and all businesses are impacted, what's the impact on the intrinsic value of a business.

  • Scenario 1- Crisis happens once in 20 years and earnings contract by 50% in the year of crisis and bounce back year after.
  • Scenario 2- Crisis happens once in 10 years and earnings contract by 50% in the year of crisis and bounce back year after.
  • Scenario 3- Crisis happens once in 10 years and earnings contract by 50% in the year of crisis, 30% in the next year and bounce back year after.

 

 

20-year cashflows

 

Perpetual

Total

Market Value

Change

 

 

Crisis Years

 

Crisis Years

 

 

 

 

 

 

Year

1

5

6

7

15

16

20

 

 

 

 

 

Current Value

            3.4

            3.4

            3.4

            3.4

            3.4

            3.4

            3.4

 

33

        100.0

                 3,000

 

Scenario 1

            3.4

            1.7

            3.4

            3.4

            3.4

            3.4

            3.4

 

33

          98.3

                 2,950

-2%

Scenario 2

            3.4

            1.7

            3.4

            3.4

            1.7

            3.4

            3.4

 

33

          96.7

                 2,900

-3%

Scenario 13

            3.4

            1.3

            2.3

            3.4

            1.3

            2.3

            3.4

 

33

          94.0

                 2,819

-6%

Note: 3.4 is derived by dividing 67 (first 20 years NPV) with no of years (20)

And thus, if the loss in value of a business based on various scenario analysis is between 3% and 6%. In comparison, the fall in stock prices is between 20% and 40%; it presents an excellent opportunity for long term investors. So rather than looking at the current situation as a threat, an investor should look at it as an opportunity. Discover why?

The human mind is not trained to think about the long term; on the contrary, it gets influenced by real-time events and extrapolates them. As Benjamin Graham said, you need to take advantage of the behaviour of Mr. Market and not get affected by it.

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