In Review – Week 18, 2024

Key market trends for last week. (1) The India Govt interest rates declined moderately. (2) Foreign investor flows into the India debt market turned moderate +ve. (3) Corporate/ Credit spreads have been flattish so far in May24, basis our analysis. (4) Global market interest rates turned up moderately. (5) Gold prices rose sharply and are broadly finding a new range between US$2300-2400 levels. (6) The India market volatility rose sharply and into normal range (15-20) – election volatility has finally found its way into India. (7) The Indian equity markets reported sharp losses alongside the rise in volatility. (8) Foreign investor flows into the India equity market turned large -ve (US$2+bn). (9) Global equity markets reported strong gains – EU/ HK. (10) Energy markets were mixed – Crude Oil flat but Nat Gas up. (11) USDollar flattish – Yen weak, other currencies flattish.

References (past writeups) :
https://determinedinvest.wordpress.com/2024/05/12/the-nifty50-bfsi-earnings-may24-update/
https://determinedinvest.wordpress.com/2024/03/22/determined-india-logistics-portfolio-p4/
https://determinedinvest.wordpress.com/2024/03/09/determined-mena-portfolio-mar24-update/
https://determinedinvest.wordpress.com/2024/02/24/determined-apparel-portfolio-closed/
https://determinedinvest.wordpress.com/2024/01/06/determined-macro-asset-portfolio-dec23-update/
https://determinedinvest.wordpress.com/2023/01/06/global-asset-allocation-quilt-2022-edition/

The Nifty50 BFSI Earnings May24 update

Continues to weaken

The analysis of BFSI sector earnings, with one-third weight in the Nifty50 Index, is a leading indicator of the market (all is well, or alarm bells). Optically 4QFY24 earnings are quite average – 13% growth in Operating profits (Figure 1). Gross profit/ NIMs (net interest margins) have continued to come down – we had warned on this. Further HDFC Bank merger with HDFC has makes reported growth look ‘optically’ higher and needs to be adjusted. On an adjusted basis, Nifty BFSI sector earnings growth would not even be 5%! – does it mean alarm bells – not quite. The principal problem is HDFC Bank, which has a very high weight (>1/3rd of Nifty BFSI sector), and where earnings have been very weak on account for very high provision costs. However, banks sometime use year-end/ 4Q to clean up the books. In particular, HDFC Bank seems to have used the HDFC merger as a ruse to clean-up its books – this surprised the market and has been the key drag on Bank Nifty Index. However, HDFC Bank profitability remains quite strong on an absolute basis and there is no need for undue concern. The second and third banks, ICICI and SBI have continued to report strong financials – we had note this in the past. India Bank Credit growth remains strong (14-15% adjusted for HDFC Bank-HDFC merger). This indicates India economic growth momentum is sustained, for now. All is not well, but also premature to start ringing alarm bells – let us just wait for 1-2 quarters.

Annexure.

Genius vs Bull Market 2024 ed P18

Sterling & Wilson RE

Never confuse a Bull Market with Brains

Climate Change, Global Warming, Energy Transition, Renewable Energy (RE) are all the rage in global economic and policy forums. And where the economy and policy go, the markets can’t be far behind. Hence Renewable Energy technologies have been a focus of the markets these past few years. Enter Sterling & Wilson Renewable Energy (SWRE) – one of the leading global Solar Power EPC companies. SWRE, when it IPO’ed in 2019, was part of the Shapoorji Pallonji group of companies. Figure 1 presents the stock returns/ performance in the last 1 year. The divergence vs its financial performance (Figure 2) is quite stark – except the IPO year (FY20), SWRE’s operating profit has been underwater throughout its journey as a listed company. Yet there is another key point – even in FY20 when SWRE was profitable, gross profit margins (Sales – Cost of Goods Sold) were below 20% and Op profit margins below 10%. Solar Power EPC/ installations are fundamentally a low-margin business. Even if SWRE financials were to recover back to FY20 levels (they wont – more on this below), the US$40mn Op profit would struggle to justify the US$2bn Mcap of the company/ stock. A low-margin EPC business ‘should’ at best be valued at 20-25X P/E ratio. Anyways, what is going on. Firstly, SWRE financials took a knock as the Govt of India slapped high duties on import of Solar Cells/ Modules, in an effort to kickstart manufacturing of the same in India. SWRE, which had fixed price installation contracts, had to pay these duties from its own pocket. The Shapoorji Pallonji group, unable to handle the losses, sold the company to Reliance group. Solar Power + Reliance – from one hot keyword to two – how could the markets resist! To be sure, Reliance group is driving strongly into the Solar Power segment in India, with SWRE becoming its exclusive EPC contractor for all future installations. So we do expect improved execution and financials going ahead – par abhi to sab hawa che!

Yet there is more to the story. Figure 3 presents the Solar Power installations data for India, courtesy of Tata Power. While SWRE was struggling with its own contracts and execution in FY23-24, the market did not stay static. The third figure (in Figure 3) shows how Solar Power execution in India hit a new high in FY24 (15 GW). Put simply, SWRE lost market share in the Solar EPC segment in India. This is very different from another RE/ Wind Power stock we discussed previously (here).

Genius vs Bull Market 2024 ed P17

MCX India

Did we mention before that we love Exchanges? Before VCs made Platform Investing cool, Exchanges were the original Platforms. We have discussed the various listed ones – BSE, IEX and MCX India – previously (here and here). MCX India is India’s leading commodity derivatives exchange with 90+% market share. The stock performance/ returns last year (Figure 1) speaks for themselves. Yet a cursory glance at the fundamentals/ financial performance (Figure 2) indicates a stark divergence in FY23-24. This is what happened – the operational performance of the exchange (commodity derivative volumes) was pretty solid, also reflected in sharply rising revenues/ sales. Yet the problem was MCX India was in the middle of a technology/ trading platform upgrade, gone awry. MCX India tech/ trading platform upgrade (with new vendor TCS) was running behind schedule, which had forced it to continue with the old tech/ trading platform but at a penal/ elevated cost. This resulted in sharp profit decline in FY23-24. Yet the situation was always temporary, and MCX India successfully made the shift by Oct23 (3QFY24). Hence we always expected the stock to do well, and it ran off since said period. Except, as we believe is the case with the rest of the Indian market, has the stock overshot its fundamentals – we believe yes. Basis normal 4QFY24 financials, we model Rs350cr-odd profit in FY25E. And at Rs21000cr Mcap, MCX India stock trades at a cool 60X P/E ratio. Being value investors, typically we are comfortable with stocks with P/E ratios up to 20-25X. But we love exchanges (high entry barriers, low capital intensive, strong cash flow generating) – so they are among the few exceptional sectors where even 40-50X P/E ratio is fine – but not 60X? Commodities are volatile and cyclical and hence also are commodity exchange revenues. But the markets are not even pretending to care about fundamentals anymore!

In Review – Week 17, 2024

Key market trends for last week. (1) The India Govt interest rates were mixed last week – LT rates down but ST rates up. (2) Foreign investor flows into the India debt market remained moderate -ve. (3) Corporate/ Credit spreads have been flattish so far in Apr24, basis our analysis. (4) Global market interest rates turned up across the board. (5) Gold prices declined sharply indicating a pause in the upcycle. (6) The India market volatility remained well below normal range (15-20) – US/ EU markets within normal range. (7) The Indian equity markets reported robust gains. (8) Foreign investor flows into the India equity market were inconsequential. (9) Global equity markets also strong – notably HK. (10) Energy markets were mixed – Crude Oil up but Nat Gas down. (11) USDollar flattish – Yen weak, rest all other currencies flattish.

References (past writeups) :
https://determinedinvest.wordpress.com/2024/04/28/the-black-gold-feb24-update/
https://determinedinvest.wordpress.com/2024/03/22/determined-india-logistics-portfolio-p4/
https://determinedinvest.wordpress.com/2024/03/09/determined-mena-portfolio-mar24-update/
https://determinedinvest.wordpress.com/2024/02/24/determined-apparel-portfolio-closed/
https://determinedinvest.wordpress.com/2024/01/06/determined-macro-asset-portfolio-dec23-update/
https://determinedinvest.wordpress.com/2023/01/06/global-asset-allocation-quilt-2022-edition/

The Black Gold Apr24 update

Finely balanced

The topsy turvy ride for Black Gold in 2023, continues in 2024. After the sharp decline in 4Q23 (from US$90 to US$70), Black Gold recouped a little more than half of the losses in 1Q24 (Back above US$80 levels). The sharp down did not make much sense; the sharp upswing does not make much either – the averages are working out just fine. Take note that 1Q is typically seasonally weak period for Crude Oil demand (decline from 4Q) and 1Q24 was no different with moderate build-up in global inventories, despite moderate (and voluntary) production cuts from OPEC. The demand-supply equation was hence finely balanced in 1Q24 – with a little help from the Artic blasts in the North America (US, Canada being top-5 producers) that kept 0.8mbd production out in Jan24. And this fine balance will continue into 2Q24 as well – although 2Q24 is seasonally strong with typically a 1mbd uptick in demand, supply will keep pace as well. The good news is broad global economic and demand momentum continues to hold up quite well. However, and this is really the critical element – looked from the long-term lens, global Crude Oil inventory levels remain on the lower side even excluding the Covid extremes (2020-21). This is the principal reason why the new normal in Crude Oil pricing (US$70-80, vs US$50 pre-Covid). That in itself is pretty good news for Black Gold investments. Yet the bigger opportunity/ challenge remains continued elevated level of geopolitical uncertainty around the world – and hardly any of this is priced into Crude Oil currently. Historically low levels of inventory and any global supply disruption is a potentially combustible cocktail – we have already seen this play out in 2022 (when the Russia-Ukraine war had just broken out).

In Review – Week 16, 2024

Key market trends for last week. (1) The India Govt interest rates rose again, in line with Western market interest rates. (2) Foreign investor flows into the India debt market turned -ve. (3) Corporate/ Credit spreads flattish so far in Apr24, basis our analysis. (4) Global market interest rates were mixed – West up, East down. (5) Gold prices above US$2400 at new all-time high levels. (6) The India market volatility remained well below normal range (15-20) – US/ EU markets within normal range. (7) The Indian equity markets reported sharp losses. (8) Foreign investor flows into the India equity market turned large -ve. (9) Global equity markets also down – Japan sharply so. (10) Energy markets were mixed – Crude Oil down but Nat Gas up. (11) USDollar flattish – Yen weak, rest other currencies flattish.

References (past writeups) :
https://determinedinvest.wordpress.com/2024/04/21/whither-europe/
https://determinedinvest.wordpress.com/2024/03/22/determined-india-logistics-portfolio-p4/
https://determinedinvest.wordpress.com/2024/03/09/determined-mena-portfolio-mar24-update/
https://determinedinvest.wordpress.com/2024/02/24/determined-apparel-portfolio-closed/
https://determinedinvest.wordpress.com/2024/01/06/determined-macro-asset-portfolio-dec23-update/
https://determinedinvest.wordpress.com/2023/01/06/global-asset-allocation-quilt-2022-edition/

Whither Europe?

Weak 2023, weak 2024E

Europe had a nightmarish 2022 to remember, led by the Russia-Ukraine war and its implications for the EU Energy supply – this is well known. Yet in early-2023, the ray of hope emerged in the form realignment of EU Energy supply chains (much less from Russia – lot more from US/ ME) without major disruptions (which was quite the surprise, yours truly included). In 1Q23, the hope was rest in 2023 may well turn out to be a recovery year for Europe. presently in 2024, that hope has been belied, with GDP growth a modest 0.4% in 2023 and even worse 0.1% in 4Q23 (weakening). There was so much focus on EU Energy supply chain link to Russia, that EU exports link to Russia was completely forgotten (we are also guilty). EU-Russia had a simple pact – Energy/ Commodities one way, Industrial goods the other way. The break in this pact did not just hurt Europe one way, but in exports of its Industrial Goods to Russia as well. After all, Russia isnt a small economy (nominal GDP of US$1.8tn in 2021). Further, EU companies with domestic operations in Russia also pulled out in the wake of the war. Unlike Energy/ Comm that are more easily replaced, Industrial goods have very specific applications/ markets. Cut to the present – IMF yet expects EU to report a modest 0.6% GDP growth in 2024E. Germany, the largest EU economy and 3rd largest globally, is notably weak (Figure 2). Of the primary drivers of economic activity – consumption, investment and government all remain weak – in fact EXIM (net exports) is the only half-pillar that EU is standing on right now. Business sentiment is weak (sharp decline in Industrial/ Manu production). Typically during periods of such weakness, Govt spending serves to kick-start economic activity – but there is very little appetite in EU Govts for spending, notably in Germany. There is only hope from two areas – (1) Consumer spending recovery led by low unemployment levels, robust wage growth and moderating inflation levels. But Consumer sentiment is low for now. (2) Continued low inflation could imply ST interest rates cut in 2H24, providing relief to businesses. Yet with already 20% returns in last 15m, the scope for rest of 2024 seems limited.

Contrast this with China. To be sure, China’s real estate sector remains in the doldrums. However, its industrial production (in this case also helped by picking up the pieces left by EU in Russia) and consumer spending are in much better health. China recently announced the centricity of its industrial policy on 3 pillars – solar cells, lithium batteries and EVs (electrical vehicles). The surprise is Europe has been much ahead of the climate change agenda globally – and yet finds itself much behind China in the Industrial production of all 3 products/ goods. Can it catch up? – is hard to say. But for now it is advantage China and European polity remains a laggard across much of its Industrial production base (except some +ve moves in Semis/ Defense).

Genius vs Bull Market 2024 ed P16

Schaeffler India

Schaeffler India, a listed subsidiary of Schaeffler AG, is the principal ball bearings manufacture for Automotive and Industrial sectors in India. Figure 1 presents the stock performance, which is nothing much to write about in 2023/FY24 – the stock has underperformed the Nifty500 Index during this period. And for good reason – post a scintillating financial performance post Covid in 2022 [25% Sales growth, 40% Profit growth], the company didnt do much in 2023. The 2022 performance was driven by both India as well as exports market – as Europe was going through the Energy crisis post the Russia-Ukraine war, Schaeffler AG passed through a lot of its manufacturing to Schaeffler India. That exceptional export performance declined sharply in 2023. Yet why are we including Schaeffler India stock in our series given its returns have been sub-par (not in a bull market). Figure 3 unwraps that mystery. Schaeffler India is only 5% of the sales and 30% of the profits of Schaeffler AG, but it is 130+% of the Market cap. Schaeffler AG (which owns majority 74% of Schaeffler India) has a Market cap of only Euro4bn, versus Euro5.5bn for Schaeffler India. Effectively the entire non-India operations of Schaeffler AG are being valued at zero/ zilch/ nil!! One of the first investment concepts we had learned during our Finance MBA was – EMH (Efficient Market Hypothesis) – guess its time to ask for our money back. To be sure, Schaeffler AG has been under considerable pressure in 2022-23 with majority >50% of operations in Europe, which have turned loss-making on account of the European Energy crisis. Hence the Schaeffler AG stock has been quite weak during this time. And the Schaeffler India stock has been in such a roaring bull market post Covid (2021-22) to completely overshadow its parent. This Arbitrage situation (Schaeffler non-India operations being valued at 0) is as much a result of bear market in Germany/ Europe as (we would argue) utopian bull market in India.

The trouble is utopia does not last. At any rate, this is further confirmation of our strongly held view that diversification away from the Indian stock market and into International stock market is the need of the hour for Indian investors.

In Review – Week 15, 2024

Key market trends for last week. (1) The India Govt interest rates rose again – ST rates remained flat. (2) Foreign investor flows into the India debt market were nothing. (3) Corporate/ Credit spreads flattish so far in Apr24, basis our analysis. (4) Global market interest rates were mixed – US up, EU down. (5) Gold prices rose sharply again and hit new all-time high levels on geopolitical risks! (6) The India market volatility remained well below normal range (15-20) – US/ EU markets were within normal range. (7) The Indian equity markets reported flattish. (8) Foreign investor flows into the India equity market turned moderate +ve. (9) Global equity markets were mixed – US down, Japan up. (10) Energy markets were mixed – Crude Oil down but LNG up. (11) USDollar reported sharp gains – Yuan flat, rest all other currencies reported weak.

References (past writeups) :
https://determinedinvest.wordpress.com/2024/04/06/global-investment-tracker-mar24-update/
https://determinedinvest.wordpress.com/2024/03/22/determined-india-logistics-portfolio-p4/
https://determinedinvest.wordpress.com/2024/03/09/determined-mena-portfolio-mar24-update/
https://determinedinvest.wordpress.com/2024/02/24/determined-apparel-portfolio-closed/
https://determinedinvest.wordpress.com/2024/01/06/determined-macro-asset-portfolio-dec23-update/
https://determinedinvest.wordpress.com/2023/01/06/global-asset-allocation-quilt-2022-edition/