December 2020 / Q3 FY21

01Peak 50,000 Captured: Time For Small-Cap Investing Is Even More Imminent Now

Post the 2018 fall, the top 20 companies grew significantly by market capitalisation as fear pushed investors into large-cap safe havens. As economic fear has now receded, the broad-based rally over the last couple of months has rekindled interest in small and mid-caps. But the dispersion is still striking.

Leaving aside the top 250 companies, the broader base of small and mid-sized companies are still way off their previous highs — leaving a significant catch-up opportunity to be encashed.

02Trends To Watch Out For

2AChina + 1

The world’s frustration with China is benefiting India, Vietnam, and Thailand. Global companies are looking at India as a manufacturing and sourcing hub post-covid to reduce dependence on China. Sectors most exposed: chemicals, pharma, textiles, auto-ancillary, and electronic manufacturing — all seeing structural shifts in demand for Indian-made products both domestically and internationally as restrictions on imports from China continue.

2BIT Services

The work-from-home regime has lifted the importance of robust IT systems and increased offshoring/outsourcing by US and European firms. The Naukri hiring index for IT Services grew 71% in the April–December 2020 period[3]. Strong growth and hiring in Indian IT services means higher employment generation and a better growth impetus.

2CPrivate Capex Making A Come-Back

The Production Linked Incentive (PLI) Scheme has been announced with a total allocation of about ₹2 trillion spread over five years under the Atmanirbhar Bharat Programme[4]. The PLI plus the September 2019 corporate-tax-rate reduction should help India become a meaningful contributor to the global supply chain. An increasing number of listed companies are announcing significant capex / capacity expansions — the green-shoots of a private capex cycle.

2DGovernment Push For Infrastructure

The government plans to invest ₹1,000 billion over FY20–25 in energy, roads, water, sanitation, metros, railways, and irrigation[4]. NHAI has placed orders for ~1,330 km and expects another 4,500 km of orders in the current year. L&T saw a 36% increase in order inflow in Q3 FY21. On-ground checks confirm a real change in government stance — projects that languished for want of funds are now fast-tracked, fiscal benefits (lower billing cycle, faster payment turnaround, lower guarantees) are yielding lower working capital and faster execution.

2EMove To A Renewable / Gas-Based Economy

The Government of India has committed to raising the share of natural gas in the energy mix from 6% to 15%, and has set an ambitious target of 20% ethanol blending with petrol by 2030. Renewable energy is gaining focus through multiple schemes.

2FContinued Domestic Consumption

Recovery plus government and private expenditure is boosting bottom-of-pyramid employment and disposable income. India is at the cusp of a per-capita-income inflection point at $2,000 — analogous to where China stood in 2006 before its exponential consumption phase.

2GAgri-Based Businesses

The rural economy is leading the post-lockdown recovery — bountiful monsoon, strong sowing season, lower covid cases, remunerative crop prices. Recent agri reforms and government schemes to improve productivity should benefit rural-focused companies.

03Risks Notwithstanding

While we remain elated about the prospects of a multi-year India growth story, we are also cognisant of challenges that could present intermittent road-blocks.

3AA Pause On Government Spending

The Modi government has historically been focused on FRBM Act 2003 fiscal discipline — even at the cost of slowing the economy in recent years. The pandemic forced the government to scale up spending; all eyes are now on Budget 2021. If the government returns to a 3–4% fiscal-deficit target, the slowdown in government expenditure could be very negative for the nascent recovery.

3BLiquidity

The recent run-up has been driven by unprecedented global liquidity and a negative / low interest-rate regime globally (you can read more about this in our June 2020 quarter update). FIIs continue to be net buyers as the US dollar index trends down and cheap capital pushes equity valuations higher. The US 10-year Treasury yield has just hit 1% for the first time since March 2020; any continuous increase will divert flows from emerging-market equities back to treasuries — challenging valuations.

3CNew Strain Of The Virus

A new strain has emerged in Britain, said to be up to 70% more contagious. India has reported 71 cases of the new strain. Several countries — including India — have banned flights from the UK, and the UK and other European countries are announcing stricter lockdowns. While the existing vaccines are claimed to address the new strain, any surge plus extended lockdowns could hamper sentiment and the global recovery.

04Our Portfolio

FY21 started with the pandemic; we had budgeted a 30–35% drop in profits with normalcy returning in FY22, assuming FY20 was a normal year. Half-way through, the recovery is sharper than budgeted — H1 FY21 has already delivered 70% recovery despite Q1 being a washout quarter.

Portfolio TTM PE stands at ~14× (which still includes the pandemic-impacted June 2020 quarter), giving us comfort to add to existing positions in expectation of strong profit growth in coming quarters. We are hopeful of an even better year in terms of our performance compared to 2020.

05In Closing

As always, please feel free to reach out to us with your comments, suggestions, and queries. Wishing everyone a happy and a healthy 2021.

Sources

01

Equitree Capital internal performance records as of 31st December 2020. Quarterly portfolio return of 28.80% and cumulative April–December 2020 return of 86%; individual portfolio performance may differ. Q2 FY21 aggregate PAT recovery of +75% YoY and +190% QoQ across portfolio companies.

02

Capitaline; NSE; Equitree Capital research — market-cap change by rank bucket (January 2018 → December 2020); Nifty 50 and Nifty Small Cap 100 distance from all-time highs (26 January 2021); Q1 FY21 vs Q4 FY20 revenue, EBITDA, and debt reduction across the two indices.

03

Naukri.com hiring index — IT Services hiring activity grew 71% in the April–December 2020 period.

04

Government of India — Production Linked Incentive (PLI) Scheme (~₹2 trillion over 5 years under Atmanirbhar Bharat); national infrastructure plan of ₹1,000 billion over FY20–FY25; NHAI ordering pipeline; natural-gas share in energy-mix target (6% → 15%); 20% ethanol blending target by 2030.