March 2023 / Q4 FY23

In this backdrop, we are glad to share that on a 3-year basis (Apr ’20 – Mar ’23) Equitree has emerged as one of the best performing portfolio managers with annualized compounded return of 45.37%[1].

We did see our share of corrections, more particularly over the last 3 months (post Q3 results) as some of our core holdings reported a margin hit due to raw-material inflation as well as lower inventory stocking due to volatility in the input prices. Despite this, we closed FY23 with a marginal drawdown of 2.36% against -13.81% return of our benchmark index Nifty Small Cap 100 — outperforming the benchmark by a good 11.45%.

With the raw-material prices cooling down, our sense is that the worst is behind us so far as the margin impact is concerned, and we should see better Q4 numbers vis-à-vis Q3.

01FY23: A Year Of Extraordinary Events

We have discussed various events that took place during FY23 in our earlier newsletters. Despite all the volatility, the headline indices of Nifty 50 and Nifty Midcap 100 delivered 0.03% and -1.34% returns respectively over the 15-month period, which may make someone believe that everything is hunky-dory. The Nifty Smallcap 100, however, fell from 11,289 (31 Dec 2021) to 8,995 (31 Mar 2023) — a 20% drawdown over the same window, with the trough at 7,983 on 20 Jun 2022 following the US Fed’s first 75-bps hike since 1994.

A detailed segment-level analysis shows ~2/3 of the total stocks have given a negative return of 33% on an average.

Some Interesting Observations

Large-cap companies with high PE ratios have seen a contraction in their PEs, whereas the Mid and Small Cap companies have seen a correction which is in line with the drop in their reported earnings.

Across all segments, the smaller number of companies which have done well on the bourses have done extraordinarily well, significantly improving the returns on an overall basis.

We find ourselves also in a similar structure where 57% of our portfolio companies have delivered significant outperformance with 49% return over the last 15 months whereas the balance is showing a drawdown of 26% on average.

Booking profits, taking cash calls, and following a staggered approach to building up the portfolio has also helped us to contain the damage as against the deep correction in the market.

02So How Should One Tread In These Kinds Of Markets?

Volatility Is Inevitable… And Life Moves On

Volatility does test an investor’s conviction all the time, but it can also be an investor’s friend — provided the investor has done his due diligence well enough.

Businesses go through their cycles and as investors in businesses (not stocks), it is best to remain invested as long as the underlying structural story is intact (irrespective of short-term blips). We explain this with an example of one of our portfolio companies — Tiger Logistics.

Case Study: Tiger Logistics

Being a logistics company, its fortunes were impacted due to the slowdown in the economy. From reporting annual profit of ₹10 cr in FY17, the company reported a loss of ₹15 cr in Q4 FY21. From being debt-free, the company had to take on debt to manage the downturn.

Through the phase, we were constantly monitoring this business, doing our own due diligence as well as talking to the promoter of the company to get a sense of the business trajectory. As soon as we got comfort that the business was improving, we started adding more towards the end of 2021. Our close monitoring of the business and continuous reassurance of the promoter’s pedigree gave us the conviction to hold on to the stock despite a significant drawdown in the absolute stock price.

03End Of Volatility May Be In Sight

We spoke about the pause of the burning issues of 2022 in our Dec ’22 newsletter. Going by the recent developments, we believe that we could be closer towards the end of the tunnel. We share our thoughts hereunder that make us believe so:

Banking crisis largely contained. The banking crisis looks to be largely contained both in the US and Europe thanks to the central banks’ swift action in preventing contagion. Further, the one-year-long funding program by the US FED suggests that the rate hikes may soon reverse, which will help banks recover the mark-to-market loss on their bond portfolio.

Rate-hike cycle nearing pivot. There are increasing talks by leading economists and US FED members battling for max one more rate hike before the FED hits the pivot. We have recently seen the RBI as well as Australia’s central bank pause rate hikes[3] as they assess the impact of past increases.

US CPI cooling. US CPI data has also been showing signs of cooling off, with the latest reading coming down to 5% from 6% reported earlier[3]. The drop in employment data also suggests that the FED may not take a very aggressive stand so far as interest rate hikes are concerned.

US economy resilient. While Europe (particularly UK) is still glaring into a possible recession coming up, the US economy has shown far more strength with the IMF latest projection showing a modest growth of 1.6%[4] rather than a recession for the US economy.

Commodity prices stabilising. Commodity prices, even though not back to pre-COVID levels, are off from their peaks and are stabilising. This would help businesses recoup lost margins as well as increase demand as channel partners look to re-stock inventory given the stability in prices.

Domestic liquidity waiting on the sidelines. FIIs have been net sellers in 10 out of the last 15 months. DII activity has also been subdued of late. Mutual funds were sitting on ₹63,000 cr of cash as of February end[5] — the highest level in the period. With India continuing to emerge as one of the fastest-growing economies, we strongly believe that a lot of this money will start getting deployed as soon as some green shoots are seen at the macro level.

04On-Ground Endorsement Of Our Focus Investment Sectors

With so much global gloom-and-doom theory questioning India’s manufacturing and industrials-driven growth, we decided to talk to some of our focus industries on the ground to get a first-hand assessment of business impact and visibility. We quote hereunder some of the interactions to showcase the kind of stuff that we are seeing.

Auto Ancillary Promoter — Import Substitution Playing Out

Industrial Battery Manufacturer — Europe+1 Playing Out

Auto Ancillary Promoter — Product And Geography Expansion

Kid’s Apparel Exporter — Vendor Consolidation Playing Out

Infra EPC Player — Strong And Sustained Order Book

Despite all the noise on export slowdown that we have been reading, the latest data on this subject shows that India’s total exports have grown to a record $770 billion in 2022-23 against $676 billion in 2021-22 — registering a growth of 14% y-o-y[6]. Of this, goods exports have grown at 6% while services exports have grown at 27%.

We understand that challenges are indeed going to be there, and one cannot paint everything with the same brush — global uncertainties will continue to plague certain businesses and create opportunities for others. The crux for us is to be able to do a ground-up analysis of businesses which can emerge stronger and leverage the opportunities as the dust settles down.

05Outlook For FY24

While the last couple of quarters got impacted due to the extreme volatility in commodity prices, this in no way has impacted the long-term structural story of our companies. We expect Q4 to be better than Q3 and lead into a much better FY24.

As normalisation sets in, we are looking at a significantly better FY24. One also needs to keep in mind that FY24 performance would have a low base of FY23 for comparison which may amplify the growth numbers for FY24 — given this, we expect PAT of our portfolio companies to grow by 30% y-o-y, on a conservative basis.

Risks

We believe that the markets may continue to be volatile over the next 3-4 months as news flow keeps coming in on interest rate hikes from the FED / RBI and other global issues. As mentioned earlier in the newsletter, our expectation is that these issues should settle down over the next couple of months and stability should come back to the markets.

On the business side — with commodity prices cooling off, the only risk that pertains is a more-than-expected slowdown in the global markets.

Valuation

We strongly believe that the recent correction in the stock price of some of our portfolio companies caused by the damp FY23 numbers should be used by investors as an opportunity to build up on the portfolio from the next 18-24 months perspective.

Time and again we come across investors trying to time the market — however in our kind of investing it may be futile to keep waiting for everything to be clear on the table before one decides to jump in. One, it actually never happens that way; and two, it doesn’t take too long for the market sentiments to change. Case in point: a swift and sharp recovery of ~5% in the first two weeks of April itself. Nothing much has changed in the underlying businesses since March to April to have driven this kind of recovery in the portfolio.

Please feel free to reach out to us with your comments, suggestions, or feedback.

Sources

01

Nuvama Custodian Services; Equitree Capital internal performance and NAV records (31 March 2023). Returns are TWRR, net of fees and expenses, and not verified by any regulatory authority/SEBI. 3-year (Apr ’20 – Mar ’23) annualised return of 45.37%; FY23 -2.36% vs Nifty Small Cap 100 -13.81%.

02

Equitree Capital — Tiger Logistics holding history. 2.6× return on initial purchase price over the holding period; 4.5× over 5 years on blended price of acquisition. FY17 PAT ₹10 cr; Q4 FY21 loss ₹15 cr; recent quarterly PAT ₹8 cr+; debt-free.

03

US Bureau of Labor Statistics — CPI all-items, 12-month change easing from ~6% to 5.0% (March 2023 release). Reserve Bank of India and Reserve Bank of Australia April 2023 monetary-policy statements pausing rate hikes.

04

International Monetary Fund — World Economic Outlook update (April 2023): US 2023 real-GDP growth projected at ~1.6%.

05

AMFI / SEBI MF data — mutual-fund cash and equivalent holdings of ~₹63,000 cr as of February 2023. NSDL FII / DII activity: FIIs net sellers in 10 of the last 15 months.

06

Ministry of Commerce and Industry, Government of India — total exports for FY23 (goods + services) at $770 bn versus $676 bn in FY22, growing 14% y-o-y; goods +6%, services +27%.