June 2020 / Q1 FY21

01A Strange Dichotomy: Markets Celebrate Liquidity, As The World Continues To Battle A Pandemic!

The dichotomy is striking. Global Covid cases have crossed 15.7 million, micro-lockdowns continue in city after city, and a vaccine remains a work in progress. Yet equity markets the world over are pricing as though the worst is behind us. The disconnect is not random — it is the visible footprint of the largest coordinated central bank intervention in living memory.

We reflect below on the four factors driving this momentum, and then on the seven reasons we believe a measure of caution is warranted from here.

1ALiquidity Support From Central Banks And Strong FII Flows

The big-four central banks have together pumped roughly US$20 trillion of stimulus into the global financial system — up from US$15.3 trillion at the end of CY19 and US$11.2 trillion at the end of CY15.[2] India has added its own liquidity support, in loans and guarantees, of approximately 4.5% of GDP.

The unprecedented liquidity has done two things at once. It has averted a looming financial crisis — without it, leveraged corporates would have been pushed into bankruptcy and the resulting job losses would have compounded the demand shock. And it has driven debt yields to near zero — the 10-year US Treasury now trades at roughly 0.5%. Bond yields and equity valuations sit at opposite ends of the same see-saw, and that move alone is enough to lift equity multiples even without an earnings tailwind.

India has been a direct beneficiary. After the March 2020 selloff of roughly ₹57,006 crore, FII flows turned positive in May (+₹13,078 crore) and June (+₹9,149 crore).[3]

1BSome Early Green Shoots In Macro-Economic Indicators

June GST collections came in at roughly 90% of average, at ₹909 billion — a sharp pickup from the April trough. The caveat: filings for February, March, and April were extended into June, so June is bulked-up by deferred liabilities and should not be read as a clean normalisation.

India Manufacturing PMI improved to 47.2 in June 2020, off the April low. A reading below 50 still signals contraction, but the slope is in the right direction. The Services PMI is recovering off a far deeper trough and remains the laggard of the two.

Energy consumption and auto sales are also showing the first marginal signs of recovery — both bottomed in April and have ticked up sequentially as the unlock has progressed.

1CSurge In Retail Participation

Lockdown-era idleness has translated into the largest first-time retail surge in over a decade. Roughly 1.8 million new demat accounts have been opened since March. Month-on-month average F&O volumes were +28% and cash volumes +18% in June 2020. Non-institutional cash share at 68% is the highest since August 2009.[4] Penny stocks have already rallied 2–3x off their lows — a familiar marker of a small-trader-led leg.

1DRobust Rural Demand Leading The Recovery

Rural India has been less Covid-impacted than urban centres. A good crop season, direct-benefit transfers, government-guaranteed loans, and MNREGA spending are together fuelling the demand recovery in rural pockets. The early read on tractor, two-wheeler, and FMCG offtake from rural belts is encouraging.

02Liquidity Notwithstanding, We Suggest Caution Ahead

We are not in the camp that reads the rally as proof the worst is behind us. Seven things deserve close watching as we move through the rest of FY21.

2ARising Covid Cases And Sporadic Lockdowns

India has now crossed 14 lakh cases, with daily additions running at roughly 50,000. The second wave is reaching deeper into rural districts. Earnings volatility is likely to persist as state-level micro-lockdowns ebb and flow with the case curve.

2BDiscretionary Spending Of The Urban Poor And Middle Class Is Impaired

The top 10 metros have been the worst-hit by the case load. Layoffs and salary cuts are widespread, and there has been no substantive stimulus aimed at the urban poor or the middle class. Discretionary categories that depend on this cohort will lag the rural-led recovery.

2CSubdued Bank Credit Growth

Bank credit growth has slowed to 6.2% in June 2020, against 11.3% in June 2019. The Atmanirbhar Bharat MSME guarantee scheme — a ₹3 lakh crore target — has seen only ~₹86,000 crore disbursed to date.[5] Private banks have turned visibly cautious in their underwriting, and the missing credit impulse is the single biggest gap in the recovery.

2DThe Overarching Fear Of Rising NPAs

The RBI has flagged that banking-system NPAs may swell to ~12.5% from ~8% currently.[6] Industry representations for restructuring are ongoing. Without a structured restructuring window, balance sheet pressure on banks and NBFCs will surface aggressively as the moratorium rolls off.

2EMore Speculation, Less Long-Term Investment

Delivery share has fallen below 33% of traded quantity in June 2020, against 40% in March 2020. A composition shift toward intraday speculation usually precedes — not follows — a healthy correction.

2FSustainability Of The Liquidity Itself

A meaningful slice of the retail deposit base is finding its way into equities only because businesses are dormant. As businesses normalise, the same capital will reverse out to fund inventory, payroll, and capex. Any rollback of central-bank fiscal stimulus would simultaneously push debt yields up and pull liquidity out of equities — the see-saw works in both directions.

2GHeadline Nifty Valuation Back At Historical Highs

The Nifty 50 trades at a TTM PE of approximately 27x, against a long-term average of around 19x. Markets have historically corrected each time the headline PE has reached the 27–28x zone. The caveat is that the index run-up has been carried by a handful of names — barring pharma, FMCG, and consumer, most sectors are still well below their previous highs.

03Our Portfolio Update

Our prior newsletter detailed the Covid stress test we ran across the portfolio. The current quarter has tested those assumptions against reality. Three updates from the ground:

3ACapacity Utilisation Back To 60–70%

After the April washout and an average May, capacity utilisation across our portfolio companies is now running at roughly 60–70% in June. We expect operating losses for some businesses in 1Q FY21, materially better outcomes in H2, and a return to growth in FY22.

3BVisible Deleveraging

Most of our companies are using this period to repay term loans and shrink working-capital limits in parallel. Capex has been deferred where it could be, and liquidity is being preserved with discipline. We see this as one of the most consequential balance-sheet improvements of the cycle.

3CFY21 Projections Cut 25–35%

We have conservatively reduced FY21 profit projections by 25–35% across most portfolio companies, with FY22 expected to deliver a handsome recovery. A couple of names have already surprised us positively in 1Q, and we are revising our numbers up for them.

04Our Strategy Going Forward

We remain cautious on the headline benchmark but continue to see deep value within our own portfolio and across the broader market segments where we have an edge. History tells us value tends to recover better than growth post-correction, and the gap between the two has rarely been wider than it is today.

Our multi-cap strategy added two new positions during the quarter, both within our circle of competence and both with margin of safety we believe is generous given the macro setup:

05In Closing

As always, we remain committed and aligned with our investors. Please reach out to us if you would like specific information on any of our portfolio companies or any other queries. Please take care, stay at home, and stay safe.

Sources

01

Equitree Capital internal performance records for the quarter ended 30th June 2020. Portfolio return of +26% for Q1 FY21; Nifty 50 of approximately +20% over the same window from NSE data. Individual portfolio performance may differ.

02

Kotak — Big-4 central bank financial stimulus comparison: US$11.2 trillion at end-CY15, US$15.3 trillion at end-CY19, and approximately US$20 trillion at the time of writing. Recreated natively from the source chart.

03

StockEdge — FII Equity Secondary Market Inflows, monthly net flows for March 2020 (-₹57,006 crore), April 2020 (-₹4,029 crore), May 2020 (+₹13,078 crore), and June 2020 (+₹9,149 crore).

04

MOSL — retail participation statistics: ~1.8 million new demat accounts opened since March 2020, MoM F&O volumes +28%, cash volumes +18% in June 2020, and non-institutional cash share at 68% (the highest since August 2009).

05

Equitree Capital ground reading from discussions with bankers and businesses — Atmanirbhar Bharat MSME guarantee scheme of ₹3 lakh crore target with approximately ₹86,000 crore disbursed to date.

06

Reserve Bank of India Financial Stability Report — projected banking-system NPAs of approximately 12.5%, against the prevailing ~8% at the time of writing.

07

Company Research; IHS Markit — India Manufacturing PMI of 47.2 in June 2020. Surrounding monthly datapoints (and the Services PMI series) are digitised from the source chart for native rendering.

08

IDFC First; MOSL — energy consumption and auto sales recovery indicators. Series digitised from the source chart for native rendering.