Market Outlook – Jan 2019

JainMatrix Investments takes a long hard look at 2018 and then builds the 2019 Outlook. 

What happened in 2018 – making sense of it 

  • CY2018 was a challenging year for investors. Many global equity indices gave negative returns, see Table 1.

jainmatrix investments, outlookTable 1 – Global Equity Indices (click to enlarge)

  • The Indian markets in 2018 were affected by various domestic and international factors.
    • The introduction of LTCG tax in Jan 2018 started the negativity after a very positive 2017.
    • Mutual Fund schemes were reclassified as mandated by SEBI, which led to MFs shifting the funds to LC stocks from Mid, Small and Micro caps and a sharp correction in MSM share prices. This was unexpected.
    • There were corporate scams (Punjab National Bank and Gitanjali Gems), auditor resignations and a new surveillance system (ASM framework) put in place by the exchanges to curb excessive trading.
    • The unfolding of the IL&FS crisis and the liquidity stress affected the NBFC sector.
    • Brent crude prices rose to $84/barrel creating worries over India’s deficit. The INR also weakened to Rs. 75/USD. Crude rose from May-Sept 2018 only to plunge sharply after that.
  • However it wasn’t all bad news in 2018. On the positive side,
    1. GDP rose sharply, as did govt. spending in Infra space. Inflation fell, giving debt investors better real returns. Domestic investors moved into equity even as FIIs withdrew from debt & equity markets.
    2. Broader corporate earnings improved after a weak 2017 due to Demon and GST. Exports sectors like IT and gems & jewellery did well due to USD strengthening against INR.
  • See Fig 2. It can be seen that Nifty fell after Sept then recovered to stay positive by year end. Mid-caps and Small caps did badly in 2018. This was a Risk-Off year after Risk-On years of 2016 and 2017.

jainmatrix investments, outlookFig 2 – Benchmark Indian Indices

  • In USA Trump reduced taxes, which gave a boost to the markets. However he soon imposed tariffs on China and broke international agreements. Interest rates were raised by the Fed. after 8-10 years of quantitative easing and low rates. The govt. has shutdown following Trump’s order for a demand to build a wall between USA and Mexico.
  • A look at Dow Jones Industrial Average (USA) and Sensex, see Fig 3, indicates that over the longer term there is a similar pattern. However in the shorter duration the movements could be more influenced by domestic factors playing out.
  • Fig 4 shows the year wise performance of these Indices.

jainmatrix investments, outlookFig 3 – Sensex and DJIA 5 year movement and Fig 4 – Year Wise Performance of Indices

the 2019 OUTLOOK

  • The 2019 outlook has key factors:
    1. On Interest rates there should be a reduction by RBI as inflation is in check and growth will be encouraged.
    2. Elections: The Rajasthan, MP and Telangana election results were BJP losses but the market was not affected. Our feeling is that coming elections will be hard fought. However the worst case scenario is not very bad for the markets and India is on a growth and reforms path that should continue.
    3. Currently the BFSI sector is recovering from the IL&FS and liquidity crisis. The central govt. and RBI have taken measures to resolve these. Interest rates have hardened. The NCLT lead NPA resolution process is bringing confidence back to markets and strengthening Banks.
    4. Auto sector is slowing in Q3, partly due to credit issues. Cement is seeing good volumes but weaker margins. Capital goods, construction and infra are positive. Power sector looks steady. Consumption sector remains strong.
    5. Real estate is weak due to RERA, GST and crackdown on black money. Demand for new housing will remain weak until prices correct, except in affordable segment. Rentals demand will be robust.
    6. We do have a situation where GoI will increase public spending. In the private sector, growth is pushing capacity utilizations, profitability is increasing and there is some reduction in overall corporate debt levels.
    7. Given weakness in USA, Europe, China and Japan, India may become a favorite again among Emerging Markets for FII flows into equity and debt.
  • The outlook on USA equities is bearish on fears of slowing growth, govt. uncertainty and rising interest rates. The tariff war is more harmful to American business, and the Trump brand is causing uncertainty.
  • In Fig 4 India on average has seen 12% growth in 4 years, lower than the long term Sensex average of 13-14%. We expect a mean reversion to higher levels.
  • This market needs patience 
  • Post elections, we project a return to Risk-On for Indian stock markets. Long term investors can expect markets to be weak in H1 CY2019 and a recovery post elections.

We wish our readers a happy and prosperous new year!

Disclaimers

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. Punit Jain has no shareholding in any listed firm mentioned in this article. 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 independent expert/advisor. Punit Jain is a registered Research Analyst and compliant with SEBI (Research Analysts) Regulations, 2014. Any questions should be directed to the director of JainMatrix Investments at punit.jain@jainmatrix.com.

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The NBFC sector selloff – is it overdone?

In the last few weeks, shares of some NBFC/BFSI stocks have fallen between 15-60%. Here we try to find out the key causes, possible timelines and suggest next steps for investors. 

The recent developments in Indian Banking Financial Services and Insurance (BFSI) sector have created a fear of systemic risks – causing stocks in general, specifically NBFCs, to correct sharply.

The IL&FS Default

  • IL&FS is a core investment firm and the holding company of the Group with firms in infra, finance, social and environmental services. IL&FS is a “systemically important” NBFC firm as per RBI.
  • In Sep2018 IL&FS Financial Services, a group firm, defaulted in payment obligations of bank loans, term and short-term deposits. It failed to meet the commercial paper (CP) redemption due on Sept 14, 2018. After this ICRA downgraded the ratings of its short-term & long-term borrowing programs.
  • The short-term paper of IL&FS saw a credit rating fall to a rating of D on 17 Sept (indicating default), down from a rating of A4 (as on 8 Sept) and A1+ (as on 6 Aug). Similarly, ILFS Financial Services short-term paper credit rating fell to ‘D’ on 17 Sept, down from A4 (as on 8 Sept) and A1+ (19 Feb).
  • Infra sector in India does face challenges like long gestation periods, low returns, and funding issues. Investments in infra should be financed by long gestation sources like insurance and pension funds.

Spill over effect on equity market

  • IL&FS has total debt of Rs. 91,000 cr. at the group level from 350+ direct and indirect subsidiaries, JV’s and associate companies. Of this debt, 61% is in the form of loans from financial institutions, indicating its woes could spread to other shadow banks.
  • Fresh inflows into MFs, especially into debt funds, slowed, and debt fund managers began to adopt a “wait and watch” policy on deploying fresh funds. A few MFs started selling short term debt instruments issued by NBFC companies including those funding the housing sector. There are concerns over short-term liquidity in the market for CPs raised by NBFCs. Further, there is also an uncertainty about the ability of certain NBFCs to raise capital.
  • Fresh bond issuances by NBFCs declined and the costs of borrowing rose. Post the default, there was a sharp decline in bond prices for HFCs which brought funding/liquidity situation of NBFCs into fresh scrutiny. This resulted in a sharp sell-offs in anticipation of rising borrowing costs, tightening liquidity situation which could impact growth sharply in turn also. Hence there was a double blow to stock price targets from earnings downgrade as well as valuation multiples downgrade (faltering growth).

What added fuel to fire?

The macro is also seeing headwinds such as:

  1. The NPA issues around Public Sector Banks (already under resolution)
  2. High Crude Oil Prices and Depreciating Rupee against USD
  3. Consistent selloff by FIIs of debt & equity; and Trade War fears
  4. Regulatory Whip on private banks – Yes Bank, Kotak Mah. Bank, Axis Bank and Bandhan Bank
  5. The merger of 3 PSBs
  6. Upcoming State and General Elections
  7. Market Rumors causing volatility
  8. Mid-year cash flow issues due to advance tax and bank repayments

Regulatory Rescue and other Positives  

  • The RBI, Finance Ministry and MCA have stepped in quickly to avert a crisis. They  took control of IL&FS, and with NCLT approval, reconstituted the board and it is now headed by Uday Kotak as chairman. The new board is focused on turning around the operations of IL&FS soon.
  • The RBI will infuse Rs. 36,000 crores through open market purchase of bonds to ease liquidity concerns.
  • A reduction in excise duty was announced to reduce petrol & diesel costs.
  • The RBI MPC kept interests rates unchanged, indicating that inflation is under control and giving a thrust to economic growth.
  • Domestic liquidity and growth of MFs was strong recently and should continue.
  • India’s GDP grew at 8.2% cent in Q1 of FY19. This is an outstanding number,the highest growth in two years. Surely the growth will also reflect in the BFSI sector, as this sector addresses both consumer and industrial credit.

Which stocks got affected the most?

  • A lot of private sector banks and many of the HFCs from the NBFC space were affected. Here is how the share prices have moved in the last 1 year.

jainmatrix investments, nbfcFig 1 – One year Normalized Price Graph / Fig 2 – In Percentages jainmatrix investments, nbfcNote: The share prices in Fig 1 have been scaled for a better representation of relative movement of all the stocks over 1 year, which may not reflect the actual share price. The 9 stocks chosen above are an incomplete but sufficient representation of the sector. 

The Outlook

  • After a few weeks of uncertainty and liquidity dry-up, the financial system will surely rebound. Short term interest rates are firming up too.
  • IL&FS may undergo a restructuring; a fresh infusion of funds – maybe a rights issue and a sale of assets will help the firm meet its debt obligations. Some strategic announcements should happen in 1-2 months.
  • The developments around IL&FS and the macro economy do call for a correction in stock prices. However the correction has been overdone in BFSI/NBFC stocks.
  • Long term investors should look at selectively accumulating the beaten down quality stocks when some signs of recovery are in place.

Appendix / Legend – Sorry we keep using shortforms

  • BFSI – Banking Financial Services and Insurance
  • NBFC – Non banking Financial Services company
  • CP – Commercial Paper
  • HFCs – Housing Finance companies, a type of NBFC
  • RBI – Reserve Bank of India – India’s Central Bank and regulator for banking sector
  • MPC – Monetary Policy Committee, a group from RBI
  • FIIs – Foreign Institutional Investors
  • MF – Mutual Fund Industry
  • NPA – Non Performing Assets
  • NCLT – National Company Law Tribunal, is a quasi-judicial body in India that adjudicates issues relating to Indian companies.

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. Punit Jain has positions in some of the firms mentioned in this report. JM objective is to draw attention to the sector rather than any specific stock. 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 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 JM at punit.jain@jainmatrix.com.

This market needs Patience

Dear investor,

You got into an amusement park. And decided to take a peaceful ride, say a merry go round. You sat down, and found to your surprise that you are actually on a High Thrill Ride, buckled in, and you cant get off.

The market today is a little bit like this ride – it can be described as a Bull market undergoing a correction.

I would like you to see this 20 minute YouTube video. Its an interview with a great Indian investor, Mr Raamdeo Agrawal. The video in Hindi describes his own journey and has important lessons for the long term investor.

(Credits – thanks to Mr. Raamdeo Agrawal and CNBC Awaaz for this content).

Think of this market correction as an opportunity. Your already invested portfolio will recover soon. In fact it is time for you to confidently continue your investing in a market looking more reasonable. 

JainMatrix Investments provides 3 Model portfolios – Large Cap, Mid & Small Cap and Satellite portfolio. These solid research backed portfolios are all you need for your long term investments.

You just need to stay calm and ride out this high thrill ride. To meet your goals. 

Here’s to your Happy and profitable investing.

Punit Jain
JainMatrix InvestmentsBangalore

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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 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.

HDFC AMC IPO – A Quality Asset

  • Date 24th July; IPO Opens 25-27th July at Rs. 1095-1100
  • Valuations: P/E 32.3 times TTM, P/B 10.7 times (Post IPO)
  • Mid Cap: Rs. 23,300 cr. Mkt cap
  • Industry – Asset Management
  • SUBSCRIBE for the IPO

Summary

  • Overview: HDFC AMC is the #2 player among AMCs by AUM and #1 by profits. HDFC operates as a JV between HDFC and Standard Life Investments. HDFC is one of India’s leading finance companies. Revenues and profit for FY18 were Rs. 1,867 cr. and Rs. 722 cr. HDFC revenues, EBITDA and PAT grew at 19.9%, 19.2% and 19.1% CAGR in 5 years. The Indian mutual fund industry is expected to grow at a CAGR of 20% between FY18 and FY22, due to buoyant capital markets, and a shift from physical to financial assets. Valuations in terms of P/E are 32.3 times, P/B at 10.7 times and market cap/AUM at 8% are high. However we have seen that in emerging sectors/ industries the excelling high quality players can command very high valuations. So a good track record, robust financial performance, sectoral tailwinds, reputed management team and good promoter identity makes this IPO attractive.
  • Risks: 1) High Valuations 2) Regulatory risks 3) Competition can impact margins 4) Macro concerns
  • Opinion: Investors can SUBSCRIBE to this IPO with a 3 year perspective.

Here is a note on HDFC Asset Management Company (HDFC) IPO.

IPO highlights

  • The IPO opens: 25-27th July 2018 with the Price band: Rs. 1095-1100 per share.
  • Shares offered to public number 2.54 crore. The FV of each is Rs. 5 and market Lot is 13.
  • The IPO is of Rs. 2,800 cr. for 12% equity by current promoters HDFC Ltd. and Standard Life Investments UK, with no dilution. HDFC Ltd. and Standard Life are selling 4.05% and 7.96% of shares.
  • The Promoter group (HDFC and Standard Life) own 95% in HDFC which will fall to 83% post-IPO, ie. 53% and 30% in resp. HDFC is a well-known Indian NBFC and is the holding company into financing the purchase or construction of houses, commercial real estate, etc. in India.
  • The IPO share quotas for QIB, NIB and retail are in ratio of 50:15:35.
  • The unofficial/ grey market premium for this IPO is Rs. 370-380/share. This is a positive.

Introduction to HDFC AMC

  • HDFC AMC is a leading Indian asset management firm into Mutual Funds and PMS Advisory. It is a JV between HDFC Ltd and Standard Life Investments. HDFC Ltd. is a leading Indian housing finance firm.
  • Revenues and profit were Rs. 1,867 cr. and Rs. 722 cr. for FY18. It has 1,010 employees out of which 58% are in sales and 29% are in client services. It had an AUM of Rs. 2,92,000 cr. in FY18. It is the most profitable AMC in India. It is the largest AMC in India in terms of equity-oriented assets and has consistently been among the top 2 AMCs in India in terms of total average AUM since Aug 2008.
  • The equity-oriented and non-equity-oriented assets are Rs. 1,50,000 cr. and Rs. 1,42,273 cr. resp. of total AUM. HDFC AUM has grown at 25.5% CAGR over FY13-18. Their proportion of equity-oriented AUM to total AUM is 51.3%, higher than the industry average of 43.2%. As equity schemes have a higher fee structure compared to non-equity schemes, the product mix helps achieve higher profits.
  • The market share of AUM is 13.7% and of active equity AUM is16.8% among AMCs see Fig 1c.
  • HDFC offers a large suite of savings and investment products across asset classes, which provide income and wealth creation opportunities to customers. In FY18, they offered 133 schemes classified as 27 equity-oriented schemes, 98 debt schemes (including 72 fixed maturity plans FMP), three liquid schemes, and 5 other schemes (including ETF schemes and funds of fund schemes).
  • This diversified product mix provides them with the flexibility to operate successfully across various market cycles, cater to a wide range of customers from individuals to institutions, address market fluctuations, reduce concentration risk in a particular asset class and work with diverse sets of distribution partners which helps them expand their reach.

jainmatrix investments, hdfc amc ipojainmatrix investments, hdfc amc ipoFig 1(a) – HDFC AUM split -June 2018 (b) HDFC Segment revenues c) Market share /Note – QAAUM is Quarterly Average AUM /Click to enlarge image view. 

  • HDFC also provides portfolio management and segregated account services, including discretionary, non-discretionary and advisory services, to high networth individuals (HNIs), family offices, domestic corporates, trusts, provident funds and domestic and global institutions. As of FY18, they managed AUM of Rs. 6,474 cr. as part of their PMS and segregated accounts services’ business.
  • HDFC had a total of Live Accounts of 81 lakh as of FY18, and their Monthly Average AUM from individuals was 62.2% of their total MAAUM, compared to the industry average of 51.4%.
  • A key element of their strategy is to promote a customer-centric culture that spans across all aspects of their business. As of FY18, they served customers in over 200 cities through their pan-India network of 209 branches (and a Dubai office) and service centers of their registrar and transfer agent, which is supported by a network of 65,000 empaneled distribution partners across India, consisting of independent financial advisors, national distributors and banks.
  • Leadership is Deepak Parekh (Chairman), Keki Mistry (Non-Exec Director), Milind Barve (MD), Prashant Jain (CIO) and Piyush Surana (CFO).

Promoter – HDFC Ltd and Group – Snapshot and Financials

  • The HDFC group is a known financial conglomerate in India, with presence in housing finance, banking, life and non-life insurance, asset management, real estate funds and education finance. Listed companies of the group include HDFC Ltd., HDFC Bank, HDFC Standard Life Insurance Co. and GRUH Finance. HDFC Ltd is the holding company and is also engaged in financing the purchase or construction of residential houses and commercial real estate.
  • Income and PAT has grown at 14.1% and 19.5% CAGR resp. over 5 years.

jainmatrix investments, hdfc amc ipoFig 2 – HDFC Financials

  • HDFC Ltd. share price gained 19.5% CAGR over the last 5 years and CMP is Rs 1,970.
  • HDFC Ltd. has visible signs of pick-up in demand for mortgage loan led by improving affordability, attractive incentive from PMAY scheme and introduction of RERA which augurs well for sustained growth in loan book for HDFC over the next 3-5 years. Further, the performance of its various financial business subsidiaries/associates has improved substantially over the last few quarters.
  • The key risks are 1) Aggressive competition among the HFCs 2) Unstable interest rate environment.
  • HDFC has a market cap of Rs 3,33,106 cr. to be ranked #6 in India.
  • HDFC is a prestigious group with good ethics. It has rewarded shareholders and performed well over decades. The listed subsidiaries of HDFC Ltd. have generally retained these qualities.

News, Updates and Strategies of HDFC AMC

  • The average cost of acquisition of equity shares for HDFC ltd. has been Rs 19.53 over 2000-18 and for Standard Life Investments it is Rs 15.01 over same period.
  • HDFC’s business strategy is as follows: 1) Maintain strong investment performance 2) Expand their reach and distribution channels 3) Enhancement of product portfolio. 4) Invest in digital platforms to establish leadership in the growing digital space.
  • HDFC has grown by acquisition, taking over Morgan Stanley AMC (2014) and Zurich India MF (2003).
  • HDFC AMC sold its shares worth almost Rs 150 cr. to distributors in April 2018 before the upcoming IPO. These shares were offered to 190 distributors and advisers at Rs. 1,050/share. But SEBI in July 2018 directed HDFC to scrap this placement and to return the money it had collected with a 12% interest. These shares were then acquired by PE firm KKR paving the clearances for the IPO. Prior to the share allotment, HDFC had sought approval for a special quota for distributors in its IPO, but SEBI rejected the proposal then because it was against a separate quota for distributors.

MF Industry Outlook in India

  • The economy has seen financial events such as demonetization, RERA implementation, GST and a crackdown on black money and shell companies. All these have rekindled interest in financial assets as compared to real estate and gold which were the most popular earlier.
  • Penetration of equities remains low, with only 2% of population having a demat or equity /MF ownership. Gold & real estate hold a large proportion of savings but have generated weak returns.
  • The regulations and disclosures around MFs have ensured good traceability and audit trails. SEBI has promoted MFs as good entry level equity and debt products, and MF asset growth has been good.
  • The MF industry’s AUM grew at a CAGR of 24.9% from Rs. 7 lakh cr. in FY13 to Rs. 21.4 lakh cr. as of Mar 2018, supported by strong investor inflows of Rs. 9 lakh cr. FY17 & FY18 have been remarkable for the industry, attracting around 68% of the Rs. 9 lakh cr. net inflow, with equities leading the charge. Equity-oriented funds (including balanced and excluding ETFs) attracted 60% of the total net inflows in FY17 & FY18. Supported by these strong inflows, growing participation from individual investors and rising equities, the assets surged 42.3% in FY17 and 21.7% in FY18. During FY18, the fresh investments in MFs grew by 22.2% to Rs. 3.9 lakh cr. in the FY 2018.
  • The growth in the AUM has been supported by a favorable macro environment, the rising of capital markets, foreign fund inflows as well as growing investor awareness.
  • Today there are 41 AMCs operating comprising 7 promoted by PSB’s, 2 by financial institutions, 25 by private sector and 7 by foreign players (including JV’s). The Indian MF industry is concentrated with the 10 large AMCs having 80% of the industry AUM. ICICI Prudential AMC, HDFC, Reliance, Birla Sun Life and SBI Funds are the 5 largest with 57% of AUM.
  • The MF industry is expected to grow at a CAGR of 20% between FY18-22, with the AUM expected to grow to Rs. 45 lakh cr. by Mar 2022. Growth rates are expected to be higher in FY19 due to buoyant capital markets and increase in retail participation, after which it may taper down. Stock broking firms too perform very well when markets are in a bullish phase.
  • Global asset management firms have struggled in India as independent MF firms. Many sold out and exited. They have had a better success rate on partnering with Indian firms as the MF JV promoter.
  • India’s MF penetration (AUM to GDP) at 12.8% is much lower than the world average of 62% and also lower than developed economies like US (101%), France (76%), Canada (65%) and UK (57%) and even emerging economies like Brazil (59%) and South Africa (49%). This is expected to grow fast.

Financials of HDFC

  • HDFC revenues, EBITDA and PAT grew at 19.9%, 19.2% and 19.1% CAGR in 5 years, see Fig 3.
  • Margins for 5 years are flat but high double digits due to good exposure to equity assets. Given the high revenue growth, flat margin is a good achievement. Absolute profits have grown fast.
  • HDFC had a RoE of 33.4% in FY18 and RoCE of 49.1%. The return ratios are high and excellent.
  • HDFC paid dividends of Rs. 405 cr. in FY18 (including DDT). The dividend payout ratio is high at 56%.
  • HDFC has been Free Cash Flow positive in the last 5 years. This is good CF management, see Fig 4.
  • 76% of the pre IPO equity shares have been pledged by a non-promoter shareholder. None of the shares held by the promoter or promoter group have been pledged.
  • The issue has been priced at Rs. 1,100 share which translates to a P/E of 32.3 times. The market cap/AUM is 8%. This is aggressive and makes the issue expensive.

jainmatrix investments, hdfc amc ipoFig 3 – Financials, Fig 4 – HDFC Cash Flow jainmatrix investments, hdfc amc ipo

Benchmarking

We benchmark HDFC against other Indian and global AMCs. See Exhibit 5. Only Reliance Nippon is a pure AMC, other Indian firms have NBFC and broking businesses. US firms are for comparison.

  • The asking PE and P/B is high. HDFC has moderate 3 year sales and PAT growth. The NBFC business segments of Indian firms has allowed faster growth.
  • The Debt is low, but again for non AMC business, the debt is necessary so it not comparable.
  • The margins are at the higher end amongst most peers from the industry. This is a positive.
  • The return ratios historically also have been very high and robust among comparable peers.
  • Note – The USA companies data is for CY2017, Exchange rate is Rs/$ of Rs 68.

jainmatrix investments, hdfc amc ipo Exhibit 5 – Benchmarking

Positives for HDFC and the IPO

  • HDFC has a market leadership in the Indian MF industry of #2 on AUM and #1 on equity AUM. Their market share of total AUM was 13.7% and of actively managed equity-oriented AUM was 16.8%.
  • HDFC has a trusted brand and strong parentage of HDFC group. The holding company and the 3 other listed group firms have done well on the stock markets. HDFC Standard Life Insurance Co was the most recent to list in Nov 2017. It has also done well post listing, up 65% on IPO price.
  • HDFC MFs have performed well with a solid approach, philosophy and risk management.
  • HDFC has a superior and diversified product mix distributed through a multi-channel distribution network. Their product mix enables them to operate through various market cycles, cater to specific customer requirements and reduce concentration risk. Strong distribution relationships also ensure the commitment of the channels for new launches and investor support and confidence.
  • HDFC has consistently had assets and profit growth.
  • HDFC has an experienced and stable management & investment teams.

Risks and Negatives for HDFC and the IPO

  • The valuations are high in terms of P/E, P/B and market cap/AUM.
  • HDFC had overextended its distributor benefits pre-IPO, and was ordered by SEBI to avoid a conflict of interest and revoke the distributor allotment of shares. HDFC realizes the importance of distributors, but needs to take care to not cross the legal or market accepted limits.
  • The global macros are looking cloudy. Trade war tensions between USA – China can escalate. A diplomatic conflict with Iran is playing out. Oil prices are trending higher. Brexit threatens the UK economy. Europe and the Euro are looking weak with poor economic outcomes for the region. In this situation a sharp deterioration on any of these parameters can affect Indian investment climate.
  • AMCs are closely regulated by SEBI and is subject to changes or tightening of norms. For example in July 2014, the holding period for long-term capital gains tax on debt MFs was increased from 12 to 36 months. It is possible that regulatory changes can affect their business in future.
  • SEBI in Oct 2017 issued a circular to categorize and rationalize the MF schemes. MFs are classified into 5 groups, i.e., equity, debt, hybrid, solution oriented and other schemes. These 5 groups have 36 categories of schemes, and only 1 scheme per category is permitted by a MF. This has resulted in many MF schemes being merged, renamed and repurposed in the industry. HDFC has complied with the SEBI changes, but the rationalization may have a adverse impact on their brands and business.
  • Competition from existing and new MFs could reduce their market share or put pressure the fees.
  • The tax on Long term Capital Gains from equity was introduced in budget 2018 in Feb at 10%, from zero earlier. This caused a correction in markets, particularly the mid and small cap stocks.
  • Competition to the MF industry is from alternatives like the PMS industry, AIF/ Hedge Funds, Private equity markets and direct equity advisory services. Many of these are the next steps for MF investors after they have started their investment journey with MFs.
  • HDFC has defocused from PMS and other segments and appears to focus on Mutual Funds.

Overall Opinion and Recommendation

  • In India there is a massive trend of financialization of assets, a move away from physical / guaranteed assets like real estate, gold and FDs, towards equity and debt.
  • The MF industry is witnessing a massive growth with total AUM’s growing rapidly in the last 10 years. The number of new investors and their portfolios has grown significantly from retail investors. In fact the domestic driven MF industry has emerged as a foil to the FII investors in India.
  • The #2 player by AUM, HDFC AMC is well managed financially, has a great brand, high margins and return ratios, low CAPEX and cost structure.
  • Valuations look high in terms of PE 32.3 times, P/B 10.7 times and market cap/AUM at 8%. However we have seen that in emerging sectors/ industries the excelling high quality players can command very high valuations (think Avenue Supermarts in Retail and group firm GRUH Finance in rural home loans). HDFC certainly faces high competition, but can pull ahead and become #1 by AUM in the next few years. So a good track record, robust financial performance, sectoral tailwinds, reputed management team and strong promoter identity makes this IPO attractive.
  • Opinion: Investors can SUBSCRIBE to this IPO.

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 stake ownership or known financial interests in HDFC AMC. He has a stake in HDFC Bank. Punit Jain may apply for this IPO in the Retail category. 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 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.

Here’s a Great Construction Achievement

Every once in a while, I come across an event or achievement that worth appreciating. Here is one such incident. It is terrific of Indian Railways to be able to do this.

Indian Railways sets record, builds subway at a busy track in 5 hrs; watch video

See LINK

Regards, Punit Jain

Do comment or share forward if you like the post.

Varroc Engineering IPO – An Auto-matic BUY

  • 25th June 2018
  • Mid Cap of Rs. 13,000 cr.
  • Industry – Auto Ancillary; IPO Opens 26-28th June at Rs. 965-967
  • Valuations: P/E 28.9 times TTM
  • Advice: SUBSCRIBE

JainMatrix Investments, Varroc IPOSummary of Report

  • Overview: Varroc Engineering is a global tier-1 auto component firm. They design, make and supply exterior lighting systems, plastic and polymer, electricals-electronics and precision metallic components to passenger car, CV, 2W, 3W and off highway vehicle OEMs directly worldwide.
  • India and global revenues are split 35:65 so they have good international presence.
  • Varroc’s FY18 revenue, EBITDA and PAT were Rs. 10,417 cr., Rs. 985 cr. and Rs. 451 cr. resp., and they grew at 13.1%, 12.9% and 18.2% CAGR in 4 years.
  • At a FY18 PE of 28.9x, valuations appear fair. It has a healthy balance sheet with conservative financials. It has good Indian and global presence.
  • Key Risks: 1) High Competition 2) Currency Risks 3) Downturn in macro-economic environment.
  • Opinion: Investors can SUBSCRIBE to this IPO with a 2 year perspective.

Other Auto Sector reports from JainMatrix Investments

Here is a note on Varroc Engineering (Varroc) IPO. You may also Download the PDF file – JainMatrix Investments_Varroc Engineering IPO_June2018

IPO highlights

  • The IPO opens: 26-28th June 2018 with the Price band: Rs. 965-967 per share.
  • Shares offered to public number 2.01 cr. The FV of each is Re. 1 and market lot is 15 numbers.
  • The IPO will raise Rs. 1,955 cr. while selling 15% of equity. The offer will be completed via an Offer for Sale (OFS) by existing shareholders of Rs. 1,955 cr. and there is no fresh issue of shares.
  • The promoter (Tarang Jain) owns 86.3% of Varroc which will fall to 85% post-IPO. The other investors 1) Omega TC Holdings (a PE firm) and 2) Tata Capital Fin. Serv. are fully exiting their 13.7%.
  • The selling shareholders are both Tata group firms that invested in Varroc in Mar 2014. The cost of acquisition was Rs. 162.4/share, so they are getting ~5x returns in 3+ years.
  • The IPO share quotas for QIB, Non Institutional Buyer (NIB) and Retail are in ratio of 50:15:35.
  • The unofficial/ grey market premium for this IPO is Rs. 55-60/share. This is a positive.

Introduction

  • Varroc is a global T1 (tier-1 companies directly supply to OEMs) automotive component group. It’s FY18 revenue, EBITDA and PAT were Rs. 10,417 cr., Rs. 985 cr. and Rs. 451 cr. resp.
  • They design, mfg. and supply exterior lighting systems, plastic-polymer, electricals-electronics, and precision metal components for PVs, CVs, 2W, 3W and off highway vehicle OEMs worldwide.
  • They are the 2nd largest Indian autocomp. group and a leading T1 mfg. and supplier to Indian 2-3W. It is also the 6th largest global auto lighting firm with 4% market share and $1 billion in sales and one of the top 3 independent exterior lighting players (by market share in 2016). Source: News reports.
  • Varroc started with the polymer business in 1990, and grew organically by adding business lines, like electrical and metallic and diversified products. Inorganic expansions – in 2012 Varroc acquired Visteon’s global lighting business, now known as Varroc Lighting Systems (VLS). In 2013, they acquired Visteon’s holding in a 50/50 JV with Beste Motor Co. Ltd. for auto lighting in China, Varroc TYC (China JV). They acquired 70% in auto accessories firm Team Concepts in 2018.
  • Varroc has 2 primary business lines, namely (i) VLS with the design, mfg. and supply of exterior lighting systems to passenger car OEMs worldwide. VLS has a portfolio of lighting products including Halogen, Xenon/high-intensity discharge, LED, OLED, Flex LED and LED pixel headlamp, catering to 5 segments in external automotive lighting. (ii) India Business with the design, mfg. and supply of auto components in India, to 2W and 3W OEMs, including exports. This offers products across 2 product lines, polymers/plastics, electrical/ electronics and metallic components. See Fig 1.

Fig 1- Varroc’s FY18 Segment Revenue/ Fig 2 – Varroc Geographic Revenue

  • Varroc has a global footprint of 36 mfg. facilities spread in 7 countries, with 6 facilities for the VLS, 25 for their India Business and 5 for others. In FY18, their largest customer contributed 18.6% of their revenue and their top 5 customers contributed 59.9% of revenue.
  • VLS has relationships with auto OEMs across the premium, mid-range and mass market pricing spectrum, like Ford, Jaguar Land Rover, Volkswagen, Renault-Nissan-Mitsubishi, Groupe PSA, FCA, a European car and an American electric car maker. The global lighting business has 185 patents.
  • Within India the 25 mfg. and 5 R&D centers form a footprint in the auto hubs, close to customers. Varroc has supplied to Bajaj Auto for 28 years across product lines, it is the largest customer contributing 18.6% and the top 6 are 50%. Other 2W customers are Honda, Royal Enfield, Yamaha, Suzuki and Hero. Export are to global 2W makers namely KTM and Volvo.
  • Leadership is Tarang Jain (MD age 56), Naresh Chandra (Chairman, 83), Ashwani Maheshwari (CEO India), T.R. Srinivasan (CFO) and Arjun Jain (head, electricals, 28). Tarang, Naresh and Arjun are related as Promoter, father and son. Stephane Vedie is the CEO of Varroc lighting, based out of USA.

Endurance Technologies – Snapshot and Varroc connection

  • Endurance Technologies is an India-based company, which makes aluminum casting (including alloy wheels), suspension, transmission and braking products. Endurance is connected with Varroc as Anurang Jain (MD Endurance) is the twin brother of Tarang Jain (Founder promoter of Varroc).
  • Income and PAT has grown at 11.6% and 17.5% CAGR resp. over 5 years. Endurance Tech had  its IPO in Oct 2016 at Rs. 472, the share has gained 176% since to Rs. 1,304.

JainMatrix Investments, Varroc IPO

  • Endurance Tech is perceived as a stable, fast growing and a high quality firm.
  • The Varroc promoters are related to the promoters of Bajaj Auto & Endurance. However even though Endurance Tech is owned by a brother, the two firms have separate businesses and different product offerings for the same customers, so they don’t compete directly. The two brothers had an amicable business split in 2002.

News, Business Notes and Strategies of Varroc

Varroc’s business strategies are:

  1. To focus on growth markets for VLS with new plants in Brazil and Morocco, to supply the South American, southern European and North African markets.
  2. To focus on increasing customer revenue for the India business.
  3. To invest in R&D, design, engineering and software capabilities and capitalize on future trends.
  4. Pursue strategic JV’s and inorganic growth opportunities.
  • In Feb 2018, Varroc entered into a JV in India with Dell’Orto S.p.A., a customer, for the development of electronic fuel injection control systems for 2W’s and 3W’s.
  • Varroc is setting up a mfg. facility in Brazil, one in Morocco and 2 in India.
  • Varroc in June 2018 opened an office in Tokyo to expand its global footprints. With this, they can now target Japanese OEMs for project management and engineering, lighting and electronics.
  • As per Tarang Jain, in the lighting business they want to be in the top 3 globally, while for the 2W business, they want to grow in India and also tap South-East Asia as they are the biggest markets. The revenue target is Rs. 20,000 cr. by FY21, double from FY18, through organic & inorganic growth.
  • Organic investments are going be about Rs 850 crore annually. Varroc has four successful acquisitions in the past, of the lighting business of US-based Visteon Corp, Tri OM for 2W lighting, IMES Poland & Italy for forging business and a small Indian firm which indicates their M&A success.
  • Varroc’s chief of Sales & Marketing Vikas Marwah quit in Apr 2018 after just 5 months. It appointed T R Srinivasan in Oct2017 as CFO taking over from B Padmanabhan, who retired after a 10-year stint.
  • Varroc is eyeing surface LEDs to drive future growth. Surface-LED technology uses thin layers of micro-optic filters and conventional LED light sources to achieve the homogeneous appearance generally associated with OLEDs. The metallic division is also targeting to grow 30% CAGR.

Automotive Exterior Lighting Industry Outlook

  • The global auto exterior lighting market had revenues of USD 17.8 bn. in 2016. Revenue grew 4.5% (FY11-16) CAGR and is expected to grow at 4.3% (FY16-21).
  • Globally, the market growth drivers are (a) increased LED penetration (b) technology innovation (c) design differentiation and (d) higher lighting content per vehicle.
  • The global auto exterior lighting industry comprises more than 20 players around the world. The main 8 players are Koito Mfg. Co., Magneti Marelli, Valeo, Stanley Electric Co., Hella KGAA Hueck & Co, Varroc Lighting Systems, SL Corporation and ZKW, which generated US$16.3 bn. in revenue, representing 91% of the total global auto exterior lighting revenue.
  • Varroc’s market share in the exterior lighting segment in India at present is reported to be 8%.

Financials of Varroc

  • Varroc’s revenues, EBITDA and PAT grew at 13.1%, 12.9% and 18.2% CAGR in 4 years, see Fig 4.
  • The 3 year PAT growth is modest. Varroc as a part of its strategy focuses on cost optimization.
  • Margins are in a range of 7.5-9.5% for EBITDA and 3-4.5% for PAT over the last 4 years. The margins are low, but at par with other OEM suppliers in the industry.

JainMatrix Investments, Varroc IPO

Fig 4 – Financials

  • Note: The FY15 figures are Indian GAAP, and FY16-18 are IND-AS numbers.
  • Varroc has a RoE of 15.9% for FY18 while the 3 year average RoE stood at 16.1% (FY16-18). The RoCE stands at 16.2% for FY18. These return ratios are moderate.
  • Varroc has been Operational Cash flow (CFO) positive in last few financial years. This is a positive. They have typically been investing available CFO for CAPEX i.e. funding expansion plans from internal accruals. It has generated FCFE in the last 3 years. See Fig 5.
  • The current D/E ratio is 0.42 which is moderate. There is ample room for the management to grow faster by raising debt. However Varroc has guided that they would not want a D/E of over 1.
  • The dividend payout ratio is low because of CAPEX needs, the FY18 ratio was 1.37%.

JainMatrix Investments, Varroc IPO

Fig 5 – Varroc’s Cash Flow  

Benchmarking

We benchmark Varroc against other comparable Indian auto ancillary companies. See Exhibit 6.

  • The PE post IPO is fair. PE ratio of Varroc is in the mid-range amongst its peers.
  • The 3 year sales and PAT growth are next to only Motherson indicating stability.
  • Margins in FY18 have improved and are also in the mid-range. The RoE for FY18 stood at 15.9% and RoCE at 16.3%. The return ratios are fair, not very low. The dividend yield at 0.05% is low.
  • In many ways, Varroc appears to be executing a strategy similar to Motherson, but are at about 1/5 the size in terms of revenue, PAT and target market cap.

JainMatrix Investments, Varroc IPO

Exhibit 6 – Benchmarking

Positives for Varroc and the IPO

  • IPO pricing and valuations are fair and at lower end of the peers.
  • Varroc has shown good financial performance and operating efficiency recently.
  • The MD appears to be hiring professionals at the next level / reporting to him, which should strengthen the firm and enable it to grow to the next level.
  • Varroc has a consistent track record of organic and inorganic growth. It has strong customer relationships with high quality OEMs in India, NorthAm and Europe.
  • Varroc has a proven business model and strategy, as seen with the success of Motherson Sumi. There is ample room to grow for Varroc in the sector globally.
  • Strong competitive position in attractive growing markets for VLS.
  • Low cost, strategically located mfg. and design footprint. Varroc has located its facilities primarily in low-cost countries but near major auto markets. They are making investments to expand into Brazil and Morocco, which would keep costs low yet deliver easily to their customers.
  • Robust in-house technology, innovation and R&D capabilities. The VLS business has 964 engineers located in 9 R&D centers, which are located in the Czech Republic, India, China, Mexico, Germany, the USA and Poland. Their R&D teams are focused on quick adoption of technology, enabling them to grow their product portfolio in line with customer expectations and industry developments.
  • Focus on expansion in auto electronics, an important trend in the industry.
  • The Varroc teams including the MD have good experience in the auto component sector.

Risks and Negatives for Varroc and the IPO

  • General economic conditions like the global trade war and protectionism.
  • Auto ancillary sector is considered a working capital and an asset heavy business. New orders involve big additions to working capital, so Varroc will need to manage growth and financial health.
  • Competition is high and Varroc may face pressure on price or margins in future.
  • Varroc is subject to environmental and safety regulations that it has to adhere to.
  • Their success depends on the success and survival of the auto models launched by OEMs. Thus several key success factors for Tier-1 suppliers are out of their control.
  • Varroc’s business is dependent on certain principal customers, especially Bajaj Auto in India. Sales to their top 3 customers for VLS were 50.7% of revenue for FY18, indicating client concentration. However this is a typical auto B2B situation.
  • Labour unrest is always a challenge in a firm with many employees. We came across news of strikes or unrest in Varroc factories in Aurangabad in 2009 and 2017. However these were quickly resolved.

Overall Opinion and Recommendation

  • The Indian auto ancillary mfg. is a high potential space with fair domestic size and growth; there are also significant global opportunities. India has many competitive & comparative advantages, so many global auto firms have set up here; there is also a vibrant two wheeler OEM sector here.
  • In this sector, Varroc has grown to a good size, has improving margins and marquee customers. It has a healthy balance sheet with conservative financials. It has both Indian and global presence.
  • Management quality is excellent with a global vision, eye for controlled growth and financial prudence and in sync with key global auto trends. Governance appears good and transparent.
  • At a FY18 PE of 28.9x, valuations appear fair, but are not cheap. We do not see a near term gain.
  • Key risks are 1) High Competition 2) Currency Risks 3) Downturn in macro-economic environment.
  • Opinion: Investors can SUBSCRIBE to this IPO with a 2 year perspective.

DISCLAIMER AND DISCLOSURE

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 stake, ownership or any other known financial interests in Varroc or any group company. 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 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.

Great Investing Wisdom

Here is a brilliant tweet from @jposhaughnessy. I have added to it some of my commentary. In the note, he touches upon the classic challenges – uncertainty, fear, under-performance, the big new industries, standing out, biases and luck. It is great investing wisdom. 

Jim O Shaughnessy My Thoughts

I’ve added a few of my thoughts, and an Indian angle.

jainmatrix investmentsjainmatrix investmentsjainmatrix investmentsjainmatrix investmentsjainmatrix investments
jainmatrix investments

Here are the links that Jim had referred to in case you are interested

Hope you liked this. Do comment below.

Punit Jain

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 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 JM at punit.jain@jainmatrix.com.