Special Edition9 min read

October 2019 / Special Edition

The Wait Gets A Little Longer: Government Awakens, Greenshoots Appear

“Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.”

Peter Lynch

Dear Investors,

We have shared various statistics on the markets and the economy through the last couple of quarterly notes. The wait for an earnings revival is taking a little longer than we had anticipated — but the policy response over the last sixty days has been the most decisive we have seen in years, and the first greenshoots of consumption and investment are now visible on the ground.

This is a mid-cycle note rather than a quarterly review. The setup it describes — most of our names trading well below their ten-year average P/E and most of them paying tax in the 30 to 35 per cent range[16] — is the foundation for the 2 to 3x upside we expect over the next 18 to 24 months as growth and re-rating play out.

01The Wait Gets A Little Longer

The slowdown that began as a financial-sector wobble has now spread visibly into the real economy. GST collection in September 2019 came in at ₹91,916 crore — a nineteen-month low[2]. Bank credit growth, the cleanest single measure of underlying activity, has decelerated sharply year on year.

% Growth YoY	Aug 2019	Aug 2018
Gross Bank Credit	9.9%	12.2%
Non-Food Credit	10.1%	13.5%

Year-on-year growth in bank credit, August 2019 vs August 2018. Both gross and non-food credit have decelerated by roughly 200 to 300 basis points in twelve months.
Source: Reserve Bank of India[1].

Auto is the canary. Vehicle production de-grew by 12.25 per cent in the April to August 2019 window across passenger vehicles, commercial vehicles, two-wheelers and three-wheelers combined[2], and domestic vehicle sales have been in de-growth for almost ten months running. The Manufacturing PMI held at 51.4 in September, unchanged from August and the lowest reading since May 2018[2]. Q1 FY20 GDP growth of 5 per cent[2] was the slowest in recent times.

The financial sector compounded the macro slowdown with three consecutive shocks: the PMC Bank and HDIL fraud, the instability at Yes Bank following its QIP, and the public-interest litigation admitted against Indiabulls Finance[2]. Each event pulled liquidity out of the system at exactly the moment the broader economy needed it most.

In Focus

The downturn is real, but it is policy-addressable. What follows is the most important shift of the last twelve months — the government has started responding decisively after eighteen months of incrementalism.

02Government Awakens With Responses, Albeit A Bit Slower

After most of FY19 spent reversing earlier positions and a Budget 2019 that the markets read as anti-investor, the Finance Minister and the RBI have moved on multiple fronts in quick succession over the last sixty days. The list is long enough to deserve being read in full.

2ALiquidity Into The NBFC And Housing Finance Channel

• The NHB credit line to housing finance companies has been raised from ₹20,000 crore to ₹30,000 crore[3].

• A Partial Credit Guarantee Scheme has been introduced for NBFC pooled assets up to ₹1 lakh crore[4], unlocking the secondary market for NBFC paper.

• ₹70,000 crore of additional bank capital has been sanctioned[5], which the government estimates will enable around ₹5 lakh crore of incremental loans.

• A loan mela across 400 districts disbursed ₹81,700 crore in its first nine-day window[6].

2BCapital Markets And Trade

• The capital-gains surcharge on FIIs and HNIs introduced in Budget 2019 has been rolled back[7].

• The Remission of Duties or Taxes on Export Product (RoDTEP) scheme has been notified, with an estimated outlay of ₹50,000 crore[8] — a clean replacement for the previous patchwork of export incentives.

2CAuto Stimulus

The government has lifted its own ban on new vehicle purchases, postponed the registration-fee revision to 2020, allowed an additional 15 per cent depreciation on dealer inventory, promised a scrappage policy, and walked back earlier signals of an outright diesel and petrol ban[9]. Read together, this is the most aggressive support the auto sector has received since 2008-09.

2DThe Headline Move: Corporate Tax Cut

Takeaway

Corporate tax has been cut from 30 to 22 per cent (before cess); MAT has been cut from 18.5 to 15 per cent; and any new manufacturing company set up after 1 October 2019 will be taxed at 15 per cent.[10] The Sensex jumped roughly 3,000 points over the two trading sessions following the announcement.

This is the single most consequential policy action for our portfolio. Most of our portfolio companies pay tax in the 30 to 35 per cent range[16] — they are direct beneficiaries of the rate cut, and the earnings uplift flows straight to the bottom line without the company having to do anything operationally.

2EMonetary And Fiscal Channels

• The RBI transferred a record ₹1.76 lakh crore of surplus and dividend to the government[11], creating fiscal headroom for the stimulus measures above.

• Repo-rate cuts cumulate to roughly 1.35 per cent over the past twelve months[12], although transmission to lending rates has been partial — only SBI and a handful of other banks have begun cutting.

• Outstanding CPSE dues to vendors and dealers have been directed to be paid before 15 October[13], releasing working capital into MSMEs.

03Not All Is Lost: Some Early Greenshoots On The Horizon

Confidence is restoring in small doses, and the micro and small-cap end of the market has begun to respond. The festive-season data through October has been better than the headline narrative would have predicted.

3AFestive Consumption: Coming Back Of The Micro / Small Caps

• Amazon clocked ₹750 crore in mobile-phone sales in the first 36 hours of its Big Billion Day window[14].

• Amazon and Flipkart together did approximately ₹19,000 crore of merchandise across electronics, beauty, baby care, furniture and private labels over the four-day festive sale[15].

• MG Hector and Kia Seltos have heavy waitlists; both have announced capacity expansion[17].

• Uniqlo did ₹2.2 crore of sales in the first two days at its maiden India store[18].

• Mercedes sold 200 cars in a single day on Dussehra[19].

3BInvestment And Earnings

• FDI inflows into India in the April to June 2019 quarter were up about 33 per cent year on year[20].

• Bajaj Finance reported 63 per cent profit growth and DMart reported 48 per cent profit growth in Q2 FY20[21] — both leadership franchises in their categories continuing to compound through the slowdown.

In Focus

Each of these data points is small on its own. Together they describe an economy where the consumer has not gone away, the leadership franchises continue to compound, and capital is willing to back India. The wait for the broader earnings revival is real, but the directional signal is unambiguous.

04Portfolio Overview

Q2 FY20 is expected to remain weak and we have scaled down our FY20 projections for most portfolio companies. That is a near-term reality. The medium-term setup is the opposite of weak.

Most of our portfolio names are trading way below their ten-year average P/E multiples[22]. Most of them pay tax in the 30 to 35 per cent range[16] and will see a direct earnings uplift from the corporate tax cut without any operational lift required. The combination of a depressed multiple and a structural margin tailwind is rare.

Takeaway

We expect an upside of 2 to 3x — and more in some cases — over the next 18 to 24 months as growth resumes and re-rating plays out. The valuations on offer in some of our names today were last seen in 2008.

We are using this window to selectively add to existing names where conviction is high and to scout new names that have come into our valuation range for the first time in years. The discipline is the same as it has always been: buy quality businesses when they are unfashionably priced, hold them through the wait, and let the combination of earnings growth and re-rating do the work.

For details on the portfolio or on any specific name, please write to us at [email protected] or [email protected].

Watch

Wishing you and your family a very happy Diwali, and a more prosperous Samvat 2076 ahead. May the festival of lights bring health, happiness and a meaningful tailwind to your portfolio.

Warm regards,

Team Equitree

Pawan Bharaddia

Co-Founder & CIO

Ssuneet Kabra

Co-Founder & CEO

Sources

Reserve Bank of India — sectoral deployment of bank credit, August 2019. Gross Bank Credit growth YoY: 9.9% (Aug 2019) vs 12.2% (Aug 2018). Non-Food Credit growth YoY: 10.1% (Aug 2019) vs 13.5% (Aug 2018). The only externally cited source in the original newsletter.

Equitree Capital — internal compilation of slowdown indicators, October 2019. GST collection September 2019 of ₹91,916 crore (nineteen-month low) per government GST data; vehicle production de-growth of 12.25% across PV, CV, 2W and 3W in April to August 2019; Manufacturing PMI 51.4 in September 2019 (lowest since May 2018); Q1 FY20 GDP growth 5%; PMC Bank / HDIL fraud, Yes Bank instability post QIP, Indiabulls Finance PIL admitted.

National Housing Bank — credit line to housing finance companies raised from ₹20,000 crore to ₹30,000 crore, announced as part of the August to September 2019 stimulus package.

Ministry of Finance — Partial Credit Guarantee Scheme for purchase of pooled assets of NBFCs and HFCs, up to ₹1 lakh crore in aggregate.

Ministry of Finance — recapitalisation of public sector banks, ₹70,000 crore announced FY20, expected to enable around ₹5 lakh crore of incremental lending.

Department of Financial Services — first nine-day loan mela across 400 districts disbursed ₹81,700 crore.

Ministry of Finance — rollback of the Budget 2019 capital-gains surcharge on FIIs and HNIs, August 2019.

Ministry of Commerce and Industry — Remission of Duties or Taxes on Export Product (RoDTEP) scheme notified to replace MEIS; estimated outlay of ₹50,000 crore.

Ministry of Road Transport and Highways and Ministry of Finance — auto-sector measures: lifting of government ban on new vehicle purchases, postponement of registration-fee revision to 2020, additional 15% depreciation on dealer inventory, scrappage policy in preparation; clarification by the Minister of Road Transport on the diesel and petrol vehicle position.

Taxation Laws (Amendment) Ordinance 2019 — base corporate tax rate cut from 30% to 22% (before cess and surcharge); MAT cut from 18.5% to 15%; new manufacturing companies incorporated after 1 October 2019 taxed at 15%. Sensex moved approximately 3,000 points over the two trading sessions following the announcement on 20 September 2019.

Reserve Bank of India — surplus and dividend transfer to the Government of India of ₹1.76 lakh crore based on the Bimal Jalan Committee framework.

Reserve Bank of India — cumulative repo-rate cuts of approximately 135 basis points over the twelve months ending October 2019; partial transmission noted with SBI and select banks beginning to lower lending rates.

Ministry of Finance — directive to public sector enterprises to clear outstanding dues to vendors and dealers before 15 October 2019.

Equitree Capital — Amazon Big Billion Day mobile sales of approximately ₹750 crore in the first 36 hours, October 2019.

Equitree Capital — combined Amazon and Flipkart festive-sale GMV of approximately ₹19,000 crore over the four-day window across electronics, beauty, baby care, furniture and private labels.

Equitree Capital — internal portfolio analysis. Most portfolio companies pay tax in the 30 to 35 per cent range and are direct beneficiaries of the September 2019 corporate tax cut.

Equitree Capital — MG Motor (Hector) and Kia (Seltos) launch waitlists and announced capacity expansion, October 2019.

Equitree Capital — Uniqlo first-store sales in India of ₹2.2 crore in the first two days, October 2019.

Equitree Capital — Mercedes-Benz India sold 200 cars on Dussehra 2019.

Department for Promotion of Industry and Internal Trade — FDI inflows in Q1 FY20 (April to June 2019) up approximately 33 per cent year on year.

Bajaj Finance Q2 FY20 results — consolidated profit growth 63 per cent year on year. DMart (Avenue Supermarts) Q2 FY20 results — profit growth 48 per cent year on year.

Equitree Capital — internal valuation review of portfolio names against ten-year average P/E multiples, October 2019. Several names trading at valuations last seen in 2008.

Previous Issue

June 2019 / Q1 FY20

The Darkest Hour Before The Dawn: Why Small Caps Are Oversold

Next Issue

December 2019 / Q3 FY20

Light At The End Of The Tunnel: Reading The Cycle Through Howard Marks

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. Forward-looking statements regarding earnings recovery, portfolio upside of 2 to 3x over 18 to 24 months, and macroeconomic projections are subject to risks, assumptions, and policy variables that may not materialise. References to specific companies (Amazon, Flipkart, MG Motor, Kia, Uniqlo, Mercedes-Benz, Bajaj Finance, DMart) are illustrative of macroeconomic and consumer 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.