How will Brexit impact Indian investors?

  • Date: Monday June 27th, 2016
  • Report Type: News Analysis 

What is Brexit?

Brexit refers to the UK including Britain, Scotland, Wales, Ireland and Northern Ireland, exiting from the European Union. This is a significant historic event as if it goes through UK will have broken off from the European Union, and will go independent in terms of economics, government, immigration, business & commerce, etc.

So what is Brexit actually about? It was about the British identity. The concern among the people of UK was about immigration and jobs. Do the British have shared interests with other European countries? Was the association helpful or harmful? People started having doubts on all these aspects, which resulted in the Brexit vote.

What were the results?

So to decide this, a referendum was held in UK on Thu 23rd June, 2016. 51.7% people voted for UK to exit the EU. It was a close decision. The Prime Minister, David Cameron has resigned as PM after people voted to leave the EU and will leave his post in 2-3 months.

Immediate Effect of Brexit Vote

It was an unexpected vote. By next day, Friday, the pound sterling had crashed by 10% against USD, the highest fall in its trading history and its lowest level since Sept 1985. The INR too weakened and stock markets across the world fell sharply – FTSE fell by 500 points while the Sensex closed lower by more than 600 points.

What might happen next?

But quitting the EU for UK is not an automatic process. It has to be negotiated with the remaining members. These negotiations are meant to be completed within 2 years but the European Parliament has a veto over any new agreement formalizing the relationship between the UK and the EU. What will happen is difficult to predict. A flow chart from BBC captures the next steps for UK and European Union:

Post Brexit-20160625, JainMatrix Investments

Click to enlarge image

Our take on Brexit Referendum Effects

Europe hasn’t been doing too well in terms of growth and economics over the last few years; this will be a further blow. One fear is that this may encourage many countries to rethink EU and conduct their own referendum. However my feeling is RoE (Rest of Europe) barring maybe some East Europe countries will stay together. They have strong ties of culture, language, proximity and history. The EU may actually become faster and more responsive to each other’s economic and financial necessities, after this shakeup.

The UK is now exposed to several new uncertainties. It will be affected by some new barriers to trade with the EU, which will come into effect soon. Many work immigrants from RoE who were allowed easy access to UK may now have to head back to their countries. This will improve job prospects locally. However UK may suffer as a financial capital, and as European headquarters for many businesses. The red hot real estate market of London may cool a bit.

How will Brexit impact Indian investors?

We have seen a high volatility in the GBP against most major currencies. Indian firms with an exposure to UK and Europe too have fallen sharply. Certainly the unexpected Brexit vote has increased uncertainties.

  1. However UK has been quite resilient to currency fluctuations in the past. The country is both a big importer and exporter, and the net effect of the recent changes has to be calculated by sector and by company to understand the specific impact.
  2. The UK based manufacturer-exporters may actually see a gain due to weaker GBP. However if they need to import significant raw materials, then product prices may have to be adjusted upwards partially.
  3. Exports from UK to the EU may see some tariff and non-tariff barriers in future. However this may be compensated by other markets and new bilateral ties. And a weaker currency.
  4. Indian companies which have invested a lot in the UK have concerns. Over 800 Indian firms have invested $2.75 billion into Britain in the last few years. Listed Indian firms with operations or subsidiaries in UK may see an immediate 10% drop in revenues and other financials due to the weakened currency.
  5. Indian firms with EU assets or subsidiaries should be less affected, as the Euro has weakened only 1.5-2%  so far. However higher pessimism prevails as the 27 country EU looks weaker economically.
  6. However note that in a 3 month period post Brexit, very little will change except these currency rates. Investors should take this as an opportunity to invest in high quality firms. The Indian investor needs to stay calm and take advantage of the situation. Read here: THE TOUGHEST LESSON IN LONG TERM INVESTING https://jainmatrix.com/2014/12/10/the-toughest-lesson/
  7. Investors in JainMatrix Investments – Model Portfolios may note that there is no change in the recommended firms due to Brexit. They may continue to hold these or invest in a SIP format as per their investment plan.

Regards,

Punit Jain

JAINMATRIX KNOWLEDGE BASE 

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DISCLAIMER

This document has been prepared by JainMatrix Investments Bangalore (JM), and is meant for use by the recipient only as information and is not for circulation. This document is not to be reported or copied or made available to others without prior permission of JM. It should not be considered or taken as an offer to sell or a solicitation to buy or sell any security. The information contained in this report has been obtained from sources that are considered to be reliable. However, JM has not independently verified the accuracy or completeness of the same. Neither JM nor any of its affiliates, its directors or its employees accepts any responsibility of whatsoever nature for the information, statements and opinion given, made available or expressed herein or for any omission therein. Recipients of this report should be aware that past performance is not necessarily a guide to future performance and value of investments can go down as well. The suitability or otherwise of any investments will depend upon the recipient’s particular circumstances and, in case of doubt, advice should be sought from an Investment Advisor. Punit Jain is a registered Research Analyst (SEBI Registration No. INH200002747) under SEBI (Research Analysts) Regulations, 2014. JM has been publishing equity research reports since Nov 2012. Any questions should be directed to the director of JainMatrix Investments at punit.jain@jainmatrix.com.

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A Repurpose for our PSUs

Thought for the day

Background: 

The Central Public Sector Enterprises were set up with the purpose of promoting “national interest” and “public investments in large industries” – something which could not be done by the private sector. This was done way back in the 1960s and 70s.
Forty years on, a lot has changed in the economic and business environments. Private sector lead by Reliance, Tatas and Bharti Group has surged ahead and shown them quite capable of setting up and handling global scale industries. Even the holy grail of “Defense” production is now being handed over slowly to Indian private sector firms. So why should GoI own large swathes of sectors like Oil & Gas, steel, other metal producers, telecom, banks, FMCG, pharma, even Indian Railways? In fact govt. ownership has actually allowed a lot of firms to fall back and wither away in terms of competitiveness and financial health (Air India!!??).

The Repurpose: 

The GoI appears to be relooking at our national “family silver” in this new environment and gearing up to repurpose our CPSEs. We feel the main purposes now should be:

  1. Just retain a few PSUs of strategic and national importance in the long run.
  2. Wherever the CPSE is in good health, is listed, and serves no major national interest, monetize these assets quickly. This can be through dividends, divestment and/or strategic sales (like Maruti !!??).
  3. Improve the health of the others, and set them up for listing, divestment and/or strategic sales.
JainMatrix Investments, CPSE

Please … not the Taj Mahal

The Capital Restructuring: 

The Central Govt. has issued comprehensive guidelines on capital restructuring of CPSEs by way of buyback, dividends, issue of bonus and splitting of shares to rake in more revenue. The finance ministry issued fresh norms which are as follows:

  • CPSEs having surplus cash can no longer invest funds in FD’s in banks, which generate a poor post-tax return of 4-5%. Every CPSE having net worth greater than Rs 2,000 crores and cash & bank balance of over Rs 1,000 cr. would have to buy back their shares.
  • Related to dividend, the new guidelines mandate that every CPSE would have to pay a minimum annual dividend of 30% of PAT or 5% of the net worth (whichever is higher) subject to the maximum dividend permitted under the current regulations.
  • CPSE’s will have to issue bonus shares if their reserves and surplus is equal to or more than 10 times of its paid up capital. Further, all CPSEs have to consider issue of bonus shares if their reserves and surplus are more than 5 times of the paid up capital.
  • The order has replaced the general guidelines on splitting of shares, by mandating that every CPSE, whose market price or book value of its share exceeds 50 times of its face value, will have to split its shares to make it affordable for retail investors. (Source Financial Express)

A quick look at some of the CPSEs we track reveals that many of these firms meet the stated criteria. The chart indicates likely corporate action by these PSUs.

  • In green are the firms that pass the criteria for the corporate action.
  • We have also calculated the dividend payable threshold, in crores, for the firms per these guidelines. It is still subject to the maximum dividend permitted regulations.
JainMatrix Investments

The new norms applied to a few PSUs

Benefits:

  • Most of these new norms are very good and uniformly benefit all shareholders. Buy backs improve the Earnings per Share of the firm, and should soon raise their market prices. Dividends, splits and bonuses are shared by both GoI promoters and all other shareholders.
  • This is also superior to the Follow on Public Offer method of encashing the GoI’s PSU shareholding, which was damaging to the share price and generally manipulated by the market participants.
  • Funds raised from these divestments/ sales should be used for infrastructure, education and capital expenditures rather than mere funding of deficits. Of course one can only hope for this kind of discipline from the GoI.

Open questions:

The real challenge before the government is to decide if it wants the CPSEs to become:

  • Independent institution and public owned firms, like ITC and L&T, benefiting the broad investing public, or
  • Owned by strategic partners/ new owners, like Maruti Suzuki, where they take over the firm for a large ownership premium, benefiting the coffers of GoI.

Either way, I have a feeling the CPSEs, PSUs and who knows, maybe even PSBs, may once again become valuable for the public shareholders !!

JAINMATRIX KNOWLEDGE BASE 

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DISCLAIMER

This document has been prepared by JainMatrix Investments Bangalore (JM), and is meant for use by the recipient only as information and is not for circulation. This document is not to be reported or copied or made available to others without prior permission of JM. It should not be considered or taken as an offer to sell or a solicitation to buy or sell any security. The information contained in this report has been obtained from sources that are considered to be reliable. However, JM has not independently verified the accuracy or completeness of the same. Neither JM nor any of its affiliates, its directors or its employees accepts any responsibility of whatsoever nature for the information, statements and opinion given, made available or expressed herein or for any omission therein. Recipients of this report should be aware that past performance is not necessarily a guide to future performance and value of investments can go down as well. The suitability or otherwise of any investments will depend upon the recipient’s particular circumstances and, in case of doubt, advice should be sought from an Investment Advisor. Punit Jain is a registered Research Analyst (SEBI Registration No. INH200002747) under SEBI (Research Analysts) Regulations, 2014. JM has been publishing equity research reports since Nov 2012. Any questions should be directed to the director of JainMatrix Investments atpunit.jain@jainmatrix.com.

New Banks: Big Changes in Small Change

Thought for the day

What are Payment and Small Finance Banks?

  • The RBI granted licenses for Payment Banks to 11 entities. This includes telecom firms Vodafone and Airtel; NBFC Cholamandalam Distribution Services; groups Reliance Industries and Aditya Birla Nuvo; and individuals Dilip Sanghvi, MD of Sun Pharma and Vijay Shekhar Sharma (Paytm). The Dept. of Posts, Fino Paytech, Tech Mahindra and National Securities Depository Ltd also made the cut.
  • The purpose of having payment banks is to reach customers mainly through their mobile phones rather than traditional bank branches. The RBI expects payment banks to target India’s migrant labourers, low-income households and small businesses, offering savings accounts and remittance services with a low transaction cost. It hopes payments banks will enable poorer citizens who transact only in cash to take their first step into formal banking.
  • It also granted 10 entities licenses to open Small Finance Banks for expanding access to financial services in rural and semi-urban areas. They are Au Financiers, Capital Local Area Bank , Disha Microfin, Equitas Holdings, ESAF Microfinance and Investments, Janalakshmi Financial Services, RGVN (North East) Microfinance, Suryoday Micro Finance, Ujjivan Financial Services and Utkarsh Micro Finance.
  • Small finance banks will offer basic banking services, accept deposits and lend to un-served and underserved sections including small business units, small and marginal farmers, micro and small industries, and entities in the unorganized sector.

SFB

Source: www.governancenow.com

 So what can payment and SMALL finance banks do?

  • Payment banks can do everything a regular bank can do – take deposits, pay bills, issue cheques and drafts etc. The only thing they can’t do is lend to the public in general. Payment banks can only lend to the government. Payment banks can also play a crucial role in implementing the government’s direct benefit transfer scheme, where subsidies on healthcare, education and gas are paid directly to beneficiaries’ accounts.
  • In the case of Small Finance Banks 75% percent of the credit advanced will need to go to sectors that are considered part of the so-called priority sector, which includes agriculture, small enterprises and low-income earners.

So how are they going to benefit us?

  • Small Finance Banks will improve the penetration of banking services. It will also help in self-employment and micro & small business creation and support.
  • Payment Banks will usher in the 2nd generation of benefits from the Telecom revolution. They will provide massive convenience to consumers in small day to day transactions, by replacing cash and reducing the cost of transactions, largely enabled by mobile phones.
  • The eCommerce and traditional Retail sectors may benefit from lower transaction costs and greater ease of payments.
  • The Banks will move more money online into formal banking channels, improving reporting, audit trails and tax collections.The persistence of cash in consumer payments in India is 68% versus 14% in the US and 11% in the UK. There is a cost associated with this, of currency and coins production and maintenance. The RBI and commercial banks are spending Rs 21,000 crore annually in currency operations. With these banks growing rapidly, currency costs to the govt. would reduce significantly.
  • These new sectors will create a lot of new jobs, both direct and indirectly. New industries are emerging because of these initiatives.

Effect on the existing Banking Sector

  • These new banks are largely going to provide incremental banking services to the underserved, so we do not expect the current banking industry to be much affected by these new banks
  • While payment technologies are going to get a massive boost from the Small Payment Banks, there is no restriction on the current PSBs and Private Banks to enter and expand in this space. Some aggressive private banks have already launched their offerings in this space.
  • Some products like Credit and Debit cards, ATMs and NEFT / RTGS type money transfer services may face some direct competition due to easier and more efficient channels of money transfer and shopping.

Happy Investing,

Punit Jain

JAINMATRIX KNOWLEDGE BASE:

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  • Visit the Investment Service page to find how you can get more. Or Click LINK
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DISCLAIMER:

This document has been prepared by JainMatrix Investments Bangalore (JM), and is meant for use by the recipient only as information and is not for circulation. This document is not to be reported or copied or made available to others without prior permission of JM. It should not be considered or taken as an offer to sell or a solicitation to buy or sell any security. The information contained in this report has been obtained from sources that are considered to be reliable. However, JM has not independently verified the accuracy or completeness of the same. JM has no known financial interests in companies named above. Neither JM nor any of its affiliates, its directors or its employees accepts any responsibility of whatsoever nature for the information, statements and opinion given, made available or expressed herein or for any omission therein. Recipients of this report should be aware that past performance is not necessarily a guide to future performance and value of investments can go down as well. The suitability or otherwise of any investments will depend upon the recipient’s particular circumstances and, in case of doubt, advice should be sought from an Investment Advisor. Punit Jain is a registered Research Analyst (SEBI Registration No. INH200002747) under SEBI (Research Analysts) Regulations, 2014. JM has been publishing equity research reports since Nov 2012. Any questions should be directed to the director of JainMatrix Investments at punit.jain@jainmatrix.com .

A View on the Indian Rupee

THOUGHT FOR THE DAY:

The Indian rupee has been weakening against the USD over time. The graphic provides one month and 5 year charts.

Charts

ExchangeRateHistory

INR to USD rates (chart credits dollars2rupees.com) 

The 5 year low for INR was 67.09 to a dollar hit in Aug 2013, in the wake of the USA Quantitative tightening scare. At that time our USD reserve holdings were low, and the market went through a period of panic and uncertainty. Thereafter, we have seen a steadiness of the INR, even though it continues to weaken against USD. We are now just 1% away from this past low.

If we look at this 5 year period, we can see that the INR weakened in this period by 47.69% absolute. This translates into 9.54% simple average, and 8.11% CAGR weakening per year.

Exchange Factors

The exchange rate is a complex function of factors such as:

  1. Trade deficit in India. Net investments including FII and FDI, remittances and outflows.
  2. Fiscal performance of Indian government.
  3. Inflation and GDP growth.
  4. Forex reserves, risk perceptions and trade outlook.

INR Outlook

  • The rise in interest rates indicated by the US Fed for Dec 2015 is another important event. If it comes through (it’s been postponed several times) it will result in some USD flowing back to USA to earn higher returns with low risk.
  • But overall India is well placed to defend its currency. On most of the factors named above, India is doing better now than in the past 5 years. My feeling is that the INR weakening of 8.1% CAGR seen in recent years should slow down to 4-5% over the next 5 years.
  • Exports from India remains an important theme in our investment portfolios, given the small base and massive potential. Sectors riding this theme are IT services, pharma and auto ancillaries.

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GST: Integration and Efficiency

THOUGHT FOR THE DAY:

GST is in the news a lot these days. Lets look at this new initiative in a little detail:

What is GST in India?

GST (Goods and Service Tax) is a comprehensive indirect tax that would be levied on manufacture, sale and consumption of goods and services at a national level. It will replace multiple taxes like CENVAT, central sales tax, state sales tax, octroi, etc. It would be levied whenever a consumer buys goods or services.

The government plans to roll out GST from April 1, 2016. Much depends on the legislative discussions and approvals. The delay in recent years in passing the GST bill has been in part due to political wrangling between the parties in power at the center, and the opposition.

efficiency

Benefits and impact of GST?

The tax sharing formula is such that big consumer states such as UP, West Bengal and Kerala will get a high share of the taxes, while the producer states such as Tamil Nadu, Maharashtra and Gujarat may lose out on revenues. To compensate, the bill provides for 1% extra tax on goods for at least two years. This extra revenue will go to the producer state. When introduced, GST will not only make the tax system simpler, but will also help increased compliance, boost tax revenues, reduce the tax levies on consumers and make exports competitive.

GST will boost the pan-India market by eliminating inter-state tax paperwork, delays in checks on state orders and stabilize prices across regions. Experts expect this to lift the country’s GDP by 1-2%.

What would be exempt from GST?

Petroleum products, potable alcohol and tobacco have been kept out of the purview of the GST. The center and the states have agreed to restrict number of exemptions to 100. All the goods and services not in this list would be taxed.

Sectors that will benefit:

  • We feel that FMCG, pharma, power sector, logistics and auto and auto ancillaries would be the sector gainers from GST implementation.
  • More than any specific sector, we feel that GST getting legislative approvals would be a confidence booster for the markets and a reforms related achievement for the central government.

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Power Sector – A Complex Challenge

THOUGHT FOR THE DAY:

The Power sector of India presents a complex set of challenges. On one hand there is no doubt that a 6-8 % growth in GDP also needs 10% growth in power supply. On the other hand, many plants set up recently are not able to supply power. Lets look at the challenges:

  • Power generation capacity – is not the main challenge. Recent programs by GoI have resulted in good and sufficient capacity increases.
  • Power distribution firms weak – The Discoms are short of funds. State wise decisions like low tariffs, free power to agriculture, T&D losses, etc have rendered discoms weak financially.
    • Power Minister Piyush Goyal announced a scheme for turning around discoms , reeling under a combined debt of more than Rs 4.2 lakh crore. Under the scheme, called the Ujwal DISCOM Assurance Yojana (UDAY ), the states will take over 75% debt of their discoms and, in return, get leeway to borrow more. So there is a ray of hope for discoms.
  • T&D losses are huge: Per a recent report almost 25% of the power generated is lost, and never gets billed for — double the global average of about 12%. This problem needs a combination of political will and tough implementation/ law and order, to plug leakages.
  • Fuel linkage issues: Power plants are set up, but the fuel, be it gas or coal, is not supplied in good quantity or at the right price. New Gas supply expected from Indian E&P firms has not materialized. High LNG prices till end 2014 rendered it uneconomic for power sector.
    • The GoI is attempting to solve this for Coal by setting up agreements between Coal India and large important consumers. Coal India has also increased production recently, improving supplies and reducing the need to import coal.
    • LNG gas scenario may change rapidly after the Qatar Gas – Petronet LNG renegotiation. Spot LNG prices in Asia have also fallen 50% in the last one year.
  • Power evacuation: Some states and regions are surplus in power, and others deficit. Not enough has been invested in a good power grids. Southern states are power deficit.
    • The govt. is inviting bids for transmission projects worth Rs 12,000 crore soon, to address the congestion in supply lines to South and East India.
  • Pollution: Power gen through fossil fuels also creates air pollution and particulate matter.
    • Renewables – solar and wind power, are getting a massive stimulus by government that is trying to build the solar generation ecosystems and is targeting a deployment of 20,000 MW of grid connected solar power by 2022.

From an investment perspective, we are positive on a few firms from the Power – Transmission & Equipment pack.

With the recent economic slowdown, we sense that even though the power deficit has reduced, many consumers are still facing power cuts and poor quality power supply. Lets hope that these new initiatives by the government address and resolve the problems in the power sector.

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The Roads Sector – Is it a Revival?

Thought for the Day:

Roads a very important sector for modern India. But India’s road sector had been stagnating since 2012, hit by both an economic slowdown and private sector disinterest. The famed PPP model had yielded poor results. A number of projects were delayed or in financial distress.

Cut to 2015, and the story may have changed. Of about 77 road projects that were languishing with the roads ministry, 34 have been shut down and rebid; 18 have been revived using govt. money, and the remaining 25 are under revival discussions. A number of decisions were taken:

  1. The govt. will award 10,000 kms of roads for construction this year by Mar 2016. That’s a far cry from 2013 when the central government could only award 1,300 kms.
  2. The govt. has also gone back to the basics and instead of a complex Public Private Partner-ship (PPP) model, has reverted to the simpler EPC model. Here the construction of the road is executed by the private firm, but funded by the govt.
  3. The govt is infusing Rs 4,000 crore to complete projects stalled due to lack of funds. In Feb this year, the govt. had decided to invest Rs 80,000 cr. in the road sector in the annual budget.
  4. The govt. will allow private developers to exit projects two years after tolling starts. After exiting, they can also apply for 80 public private partnership (PPP) projects.
Roads (JainMatrix Investments)

Roads (JainMatrix Investments)

These decisions are expected to rapidly stimulate this sector. Road transport and highways minister Nitin Gadkari is upbeat about the “transformation” of India’s road network. The NHAI too is undergoing reforms, for faster approvals and project revivals.

Watch out for shares of infrastructure companies into the roads and construction space like KNR Constructions, RPP Infra, Sadbhav Engineering, IRB Infrastructure, Ashoka Buildcon, Jaypee Infra, IL&FS Transportation, GMR Infra, Lanco Infra, IVRCL, Ashoka Buildcon, etc. which are likely to benefit due to these new initiatives.

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