--- title: "Peak 50,000 Captured: Why Small Caps Are Set To Catch Up | Quarterly Newsletter - December 2020 / Q3 FY21" period: "Q3 FY21" published: 2021-01-31 modified: 2021-01-31 url: https://equitreecapital.com/insights/newsletters/december-2020 markdown: https://equitreecapital.com/insights/newsletters/december-2020.md authors: ["Pawan Bharaddia", "Ssuneet Kabra"] publisher: "Equitree Capital Advisors Private Limited" language: en-IN --- # Peak 50,000 Captured: Why Small Caps Are Set To Catch Up Quarterly Newsletter, December 2020 / Q3 FY21. Published 31 January 2021 by Equitree Capital. About 11 minutes to read. Web version: https://equitreecapital.com/insights/newsletters/december-2020 > Quarterly Newsletter published 31 January 2021. Figures are as of the dates stated in the letter and are not updated after publication. > Performance data has not been verified by SEBI. Past performance is not indicative of future returns. > Current performance, with its as-of date and benchmark: https://equitreecapital.com/pms > Performance relative to other portfolio managers in the same strategy: APMI, https://www.apmiindia.org/apmi/IaInsight.htm?IAID=407 > Not investment advice, an offer or a solicitation. > Money is always eager and ready to work for anyone who is ready to employ it. > > Idowu Koyenikan Dear Investors, **Unprecedented liquidity from the global central banks and a better-than-expected economic recovery kept markets buoyant through the December quarter** — the Nifty delivered another **24% during the quarter**. **Our portfolio compounded 28.80% in the quarter and 86% cumulatively from April through December 2020**[1]. Some of our positions are already **3–4× off their March 2020 lows**, and the September quarter earnings surprised positively across the portfolio with strong forward visibility. ## Our Performance | Returns | Q3 FY21 (Quarter) | Apr–Dec 2020 (9-Month Cumulative) | | --- | :---: | :---: | | Equitree Capital | 28.80 | 86.00 | | Nifty 50 | 24.00 | N/A | As on 31st December 2020. Quarterly returns; cumulative captured from April 2020 to December 2020. Individual portfolio performance may differ. Source: Equitree Capital internal performance records[1]. ## 01. Peak 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. [Chart: Market-Cap Change, January 2018 → December 2020. Top 10 names compounded; the broader base is still way below 2018. Drawn on the web page: https://equitreecapital.com/insights/newsletters/december-2020#peak-50000] Series: Mcap change. % change in aggregate market cap by rank bucket. Source: Capitaline; Equitree Capital research[2]. **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.** | Index | All-Time High | March Low | 26-Jan-21 | % From Previous High | | --- | ---: | ---: | ---: | ---: | | Nifty 50 | 14,736 | 7,511 | 14,239 | 3.4% | | Nifty Small Cap 100 | 9,600 | 3,202 | 7,262 | -24.3% | Distance from all-time highs — Nifty 50 vs Nifty Small Cap 100, snapshot 26 Jan 2021. Source: NSE; Equitree Capital research[2]. > **In Focus:** **The Small Cap Index is still 24% below its previous high, even as the Nifty 50 has just made a new all-time high.** Better financial performance is also accruing to the small caps: | Index | Revenue Growth | EBITDA Growth | Debt Reduction (ex-Banks) | | --- | ---: | ---: | ---: | | Nifty 50 | -7% | +9% | -0.3% | | Nifty Small Cap 100* | +2% | +25% | -6% | Q1 FY21 vs Q4 FY20 — revenue, EBITDA, and debt across the two indices. *Adjusted for companies whose latest results have not been published. Source: Capitaline; Equitree Capital research[2]. > **Takeaway:** **Since most of the big guys are trading at significantly higher valuations, we believe the value stocks should now lead the next leg of the rally — most of which fall into the mid- and small-cap category.** ## 02. Trends To Watch Out For ### 2A. China + 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. ### 2B. IT 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. ### 2C. Private 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. ### 2D. Government 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. ### 2E. Move 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. ### 2F. Continued 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. ### 2G. Agri-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. > **Takeaway:** **These structural trends should present significant investment opportunities across the entire value chain catering to these segments and unleash a multi-year earnings-growth visibility for these companies.** ## 03. Risks 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**. ### 3A. A 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. ### 3B. Liquidity 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](https://equitreecapital.com/insights/newsletters/june-2020)). 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. ### 3C. New 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. ## 04. Our 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**. | Particulars | Q2 FY21 PAT — YoY | Q2 FY21 PAT — QoQ | | --- | ---: | ---: | | Aggregate PAT of portfolio companies | +75% | +190% | Aggregate Q2 FY21 PAT recovery across the Equitree portfolio. Source: Equitree Capital portfolio analytics[1]. > **Takeaway:** **Based on business visibility, we have revised our estimates upwards** — expecting a **flattish to marginal de-growth for FY21** and a **return to the growth trajectory in FY22**. **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.** ## 05. In Closing As always, please feel free to [reach out to us](https://equitreecapital.com/contact) with your comments, suggestions, and queries. **Wishing everyone a happy and a healthy 2021.** Warm regards, Team Equitree - Pawan Bharaddia, Co-Founder & CIO (pawan.b@equitreecapital.com) - Ssuneet Kabra, Co-Founder & CEO (skabra@equitreecapital.com) ## Sources 1. 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. 2. 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. 3. Naukri.com hiring index — IT Services hiring activity grew 71% in the April–December 2020 period. 4. 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. ## Disclaimer This newsletter is prepared by Equitree Capital for informational purposes only and is directed at existing investors of its Portfolio Management Services. It does not constitute investment advice, an offer, or a solicitation to buy or sell any securities. Past performance is not indicative of future results. Returns are computed on a TWRR basis, net of fees and expenses, and are not verified by any regulatory authority. Individual portfolio performances may vary. Forward-looking statements are subject to risks and assumptions that may not materialise. References to listed companies (such as L&T) are illustrative of macro trends and are not a recommendation to buy or sell. Investments in small- and micro-cap equities carry higher volatility, liquidity, and business-specific risks, including the possible loss of principal. Equitree Capital is a SEBI-registered Portfolio Manager. Recipients should consult their independent financial, legal, and tax advisors before making any investment decisions. This document is private and confidential. It may not be reproduced, redistributed, or published, in whole or in part, without the prior written consent of Equitree Capital.