June 2021 / Q1 FY22

01Market Scales New Peaks: Some Correction Imminent, But The Underlying Tone Remains Bullish

A 5–7% correction would be healthy at these levels. The headline indices have run hard, valuations are not cheap, and the easy comparisons against the FY21 covid trough flatter every chart. But the underlying tone of the market remains bullish because the foundations beneath the rally are real — and they are five.

1AIndian Corporates Have Deleveraged Like Never Before

Indian corporates entered FY22 carrying their cleanest balance sheets in a decade — a thread we first picked up in our December 2020 quarterly newsletter. The State Bank of India research team has now documented that debt across 15 key sectors fell by more than 20% in FY21 — a one-year deleveraging of more than ₹1.7 lakh crore across over 1,000 entities. Tata Steel alone cut roughly ₹30,000 crore of debt in FY21; SAIL another ₹16,150 crore in Q4 FY21.

1BIndia Is On The Cusp Of A Huge Capex Cycle

A deleveraged corporate sector with strong cash flows is the necessary pre-condition for a private capex cycle. The signs that the cycle is beginning are already in print:

1CUnorganised To Organised Shift

Covid hurt the unorganised sector more than it hurt the organised. Compliance costs (GST, e-invoicing), formal credit access, and supply-chain reliability all favour the listed and branded players — and the gap is widening, not closing. We see this in the order books of our portfolio companies in apparel, packaging, building materials, and auto-ancillaries.

1DExports On A Tear

India clocked an all-time-high quarterly merchandise exports of about $95 billion in Apr–Jun 2021. Combined with the China + 1 narrative we wrote about in earlier newsletters, the export runway is the longest it has been in fifteen years.

1ERural Income & Vaccination Drive

A normal monsoon, MSP support, and an accelerating vaccination drive are stabilising rural income and consumption. The aggressive vaccination roll-out is the single biggest input to a normalised second-half FY22.

02Things To Be Watchful For

Conviction and watchfulness are not opposites. The bull case stands, but four things deserve close monitoring through the back half of the year.

2AContinued FII Selling

FII outflows have continued — about ₹16,204 crore in July alone, and roughly ₹34,000 crore cumulatively since April 2021. Despite this, the Nifty is up about 5% over the same window, absorbed by domestic flows.

2BValuations At The Headline Level Are Not Cheap

The Nifty trades at about 22× FY22 and 20× FY23 earnings, factoring in roughly 40% earnings growth in FY22 and 14% in FY23. The math leaves little margin for earnings disappointment at the index level — though our portfolio companies trade at materially lower multiples.

2CA Third Covid Wave

A third wave is the single biggest tail risk to the recovery thesis. The vaccination drive is the single biggest mitigant. Watch the trajectory of both.

2DInflation And Commodity Prices

Steel, copper, crude — input costs are squeezing margins across our portfolio companies and across the listed universe. The next two quarters will test how quickly companies can sequence price increases. We expect the pass-through to be transitionary as supply chains normalise.

03Our Portfolio

Aggregate FY21 portfolio earnings grew about 8% YoY despite covid; Q4 FY21 grew 52% QoQ. We expect the portfolio to compound at about 28% PAT growth in FY22 off a clean balance sheet — portfolio Net D/E is at 0.2× and the average FY22 PE is around 16×.

Below the headline, the dispersion across the broader market is striking. Even with the indices at all-time highs, roughly 30% of the listed universe is still 20–50% below its all-time high, and another 33% is more than 50% below its all-time high. Plenty of fishing left in waters that have not yet been bid up.

04What We Are Doing Currently

The base effect of FY21 will not repeat. The +139% one-year number will compress as the comparison window resets. Our long-term framing remains a 20–25% IRR through the cycle — not because the markets owe us that, but because the underlying earnings of our portfolio companies should compound at that rate, and we have bought them at valuations that already discount the macro snakes.

We are deploying selectively into businesses where the price has not caught up to the earnings runway — particularly in apparel exports, building materials, auto-ancillaries, and capital goods. We are also booking partial profits where valuations have run ahead of fundamentals and using the proceeds to fund the next conviction position.

05In Closing

As always, please feel free to reach out to us with your comments, suggestions, and queries. The macro setup, the corporate balance sheet, and the on-the-ground capex signals all point in the same direction — and we are positioned to participate in the early innings of what we believe is a multi-year cycle.

Sources

01

Equitree Capital internal performance records as of 30th June 2021. Returns over one year are annualised; individual portfolio performance may differ. 1Y outperformance: +28.7 ppt vs Nifty Small Cap 100, +87.0 ppt vs Nifty 50.

02

SBI Research; Capitaline; Equitree Capital — debt reduction across 15 key sectors in FY21. Cumulative reduction of more than ₹1.7 lakh crore across over 1,000 entities. Tata Steel cut ~₹30,000 crore in FY21; SAIL ~₹16,150 crore in Q4 FY21. Reconstructed from the source chart for native rendering.

03

Capitaline; Equitree Capital research — distribution of the listed universe by distance from all-time high, as on 30th June 2021. Approximately 30% of stocks 20–50% below ATH and 33% more than 50% below ATH.

04

Spark Capital research note — core sector capex (cement, metals, oil refining, power) of ~₹5 trillion over the next three years. ONGC FY22 guidance and Tata Steel five-year plan are from company communications.