Liquid optimism

Any monkey could have performed well where everything was going up as they were trading cheap and low. If your returns have come because of skill, you will still find opportunity but if it is pure luck and if you want to be lucky a second time, the casino would be a better choice than the stock market.” This is not the rant of a sore investor who has been stranded on the sideline by the blistering run up that has been underway for a year now in the Indian stock market. Instead, these words belong to the usually calm and serene sounding Nilesh Shah, chief executive of Axis Capital. When a veteran like Shah feels that the going in 2014 has been way too easy, it must surely have some element of truth in it. And the numbers bear that out to a great degree. Those who have invested in an index ETF over the past three to 15 months are sitting on 11% to 50% return. Even those who got in late in May 2014 are now sitting on a 25% return. 

Bears or any semblance of bearishness has been steamrolled in this runaway rally which can be divided into pre- and post-Modi. For those who stayed invested in late 2013 and have held on for most of 2014, it has been nothing short of a dream run. The base building for this uptrend began soon after the rupee bottomed out in the last week of August, 2013. Hence, that has been chosen by us as the starting point for listing the outperformers. Stock-specific returns for many companies are off the charts and for many sectors; the outperformance was fortified in the catch-up rally that ensued once it became clear that a decisive mandate had come through. 

Though, every sector has seen a jump in valuation, the relative sector laggards pop up if one compares the present index levels to the highs reached during the frenzy of 2008 (see: Leaders and laggards). While the consumption and defensive sectors have left the highs of the 2008 euphoria in the dust and many a skeptic has been buried under the current market momentum, the BSE capital goods and metals indices have some way to go before they register new highs. When the financing environment gets better, it is the beaten-down sectors that bounce back the most as during the trough, investors price it for bankruptcy. Surprisingly, the bounce has not been that evident in the power and infra space as seen in their tepid performance over the past six months. Though the BSE power index is up 25% for the year, most of that gain has come in the pre-Modi run-up. 

Leaders and laggards

Of all the BSE indices, those driven by capital expenditure are still to breach the highs reached in the frenzy of January, 2008

And contrary to the widespread expectation that FMCG and pharma might lose some of their gloss due to their high valuation, the BSE FMCG and healthcare indices are up 24% and 50% year to date, respectively. FMCG has outperformed because even as urban buyers were feeling the pinch of higher inflation and a tight job market, rural India was having a ball due to higher minimum support prices. That apart, the impact of election spending and earlier government’s populist policies such as NREGA and interest subvention kept demand high. This was not only seen in the uptake of autos, particularly two-wheeler and passenger vehicles but also in the huge offtake of consumer durables. “Most cooling product companies have grown at 40%-50% in terms of revenue growth, which is largely driven by huge demand in the rural market and particularly the extended summer,” says John Perinchery, analyst, Emkay Global. 

As for healthcare, midcap pharma companies have gained as the US market opened up after President Obama pushed through the Affordable Care Act. “Over the years many products have gone off-patent and these companies prepared well to tap these opportunities, which were largely restricted to larger players. Midcaps have learned the process of approval and companies such as Torrent today have the largest number of US FDA approved plants in the country,” says Siddhant Khandekar, pharma analyst, ICICI Securities. Consequently, the valuation gap between large cap and midcap pharma companies has reduced because of higher earnings visibility and improvement in margins.

Seconds…anyone?

If 2014 has been a dream year for equity investors, most expect the good times to continue. The Indian arm of Nomura Securities in its latest report articulates that 2015 will be a Goldilocks year, where higher growth and lower inflation awaits. It expects GDP growth to bounce back to 6.4% in 2015 and 6.8% in 2016 respectively. In a way, it pretty much sums up the hope of the entire market: that the prevailing feel-good will soon translate into investments on the ground and, in turn, push the wheels of the economy into higher gear. “India’s capex J-Curve will be kick-started by reorientation of fiscal expenditure, which could accelerate spending on flagship government projects and the government’s attempt to address contentious issues in several sectors, leading to increased capex by central and state public sector units. This phase will be followed by a revival in industrial cycle, which will culminate into traction in greenfield and mega projects,” says Rajat Rajgarhia, managing director, institutional equities, Motilal Oswal Securities. 

For now, revenue growth in the infra sector continues to be below 5% due to execution issues and the order-book is about 2.4 times sales compared with 3 times in FY11. Then, despite lower commodity prices, operating margins are hovering at 7-8%, half of that during the peak.  However, analysts believe that once the capex environment improves, we could see some multi-baggers from this space. While there is some amount of wariness about heavily indebted infra companies, Saurabh Mukherjea, chief executive, institutional equities, Ambit Capital is bullish on light industrial manufacturing companies. “In India, manufacturing accounts for merely 25% of GDP. But with the government’s renewed focus on manufacturing, even if we grow at 5%, we will be an Asian tiger. Companies like Triveni Engineering, PI Industries, Wabco and Balkrishna Industries could be among the beneficiaries,” he says. Already, Balkrishna along with other tyre companies like Ceat and Apollo have been lifted by a fall in the price of its prime raw material, rubber. “Most of the outperformance we have seen is because of the lower rubber prices which have straight away expanded their margins on a low base. Also, replacement demand has picked up as a result of double-digit growth in auto sales in 2010 and 2011,” reveals Prateek Kumar, analyst, Religare Capital Markets. 

Logistics companies like Gateway Distriparks and Gati also are a part of the list. In fact, the latter is the table topper and mea culpa as in February 2014, Outlook Business had advised to wait and buy after the sharp initial run up from ₹30 to ₹65. The stock only corrected about 10% to ₹57 before resuming its uptrend and now trades at ₹275. Its cold chain arm Kausar receiving a capital infusion from Mandala Capital only added fuel for a parabolic burst from ₹200 to ₹330. See the stock become a 10-bagger in less than a year makes us look sheepish, to say the least. One may carp about its P/E of 90, but then, a lot of investors made some real fast money.

Trophy market

After a string of such multi-baggers in 2014, India has now acquired the status of a must-invest emerging market and is getting its fair share of attention. “Managers of diversified global emerging markets equity funds have lifted their India allocation to a record high of 11.49%,” points out Cameron Brandt, director of research at EPFR, which tracks global money flow across markets and asset classes (see: The Modi effect). This return cycle plays its own role in pulling in fresh money. While it is facile to term it as a Ponzi scheme, the fact of the matter is foreign flows are needed to keep the momentum going. So far, we have not been let down. “Year-to-date, the bulk of the money has come from ETFs. Since the start of the third quarter of 2014, however, the split has been 60-40 between ETFs and long-only mutual funds. So the longer term money is beginning to move in,” assures Brandt.

The Modi effect

Emerging market fund managers have increased their allocation and are now overweight India

With the expectation of lower rates and benign liquidity, the ‘buy on dips’ mentality has taken firm hold and a prolonged dip in the Indian market has become as rare as a Seth Klarman interview. This ebullience is a global phenomenon. Not only are the Dow and the FTSE trading near their all-time highs, the Nikkei, too, is trading at a seven-year high as Japanese investors as well as exporters are celebrating a weak yen. Japan’s GDP shrinking 2% in the third quarter of 2014 after the earlier negative number of 7.3% in the second has only increased their desperation and while the Japanese themselves are happy about the plummeting yen, it could create its own worry for its fellow exporters in South East Asia, primarily China. A combination of public spending and monetary easing is being backed by Japan to push itself out of deflation but more than the Japanese, it is many an arb desk which is going, “Yen, we can.” India is no different and is experiencing increased yen-denominated flows says Brandt. “This is significant, as Japan is likely to be the major source of global liquidity through the first half of 2015,” he adds.

If you run through the financial data in the listing table on pages 60-65, you will notice that there has not been a runaway improvement in financial performance for most outperformers. But that is the nature of the beast. Indeed, looking backwards, everyone can be a multimillionaire but markets are clearly about looking forward. Brandt is unsure about what could upset the gravy train. “Aside from the usual geopolitical risks – spike in oil prices, increased tensions with Pakistan or China, I would say the biggest risk is more emerging markets starting to get their economic policy houses in order. Given investors’ marked preference for diversified exposure, a shift to more orthodox policies in Brazil and some successful reforms in Indonesia would likely attract some of the money currently flowing to India to these markets,” he posits. 

The weight of expectations now has turned burdensome and the Sensex seems pausing for a break. While it is yet to show any sign of giddiness, expectations are running ahead of themselves. Shah cautions, “Undoubtedly, last year people had the advantage of a rising tide. However, the next year will be difficult as we are not going to have the same advantages that we had last year, so the return expectations are relatively low.” Now, how low is the question? To which we do not have the answer, nor does anybody out there. What we did try to understand is what some of these outperformers did right. Their stories are detailed in the pages that follow.