Investment Advisor s Commentary for India Emerging Opportunities Fund Jul 2018
TABLE OF CONTENTS 1. Business Head & CIO s Commentary...2 2. Fund Manager s Commentary......3 3. Fund Strategy..... 4 1
Business Head & CIO s Commentary Most investors seek quality and long period growth combination at justifiable valuations as the best combination. In our opinion, the financial sector offers the same in a better manner as compared to most other sectors on following reasons: Well-run entities are seeing a sharp drop in Cost to Income Ratio: well run banks and NBFCs which are growing well have been able to expand branch network to the extent required and are able to use technology to gain market access. Hence, cost to income ratios for most entities growing well has been dropping sharply overtime. A reduction in cost to income in a scenario of stable margins implies large value creation for investors. Margins are expected to remain stable because this phenomenon is seen only in well managed growing entities. PSU banks that still account for bulk of lending in the country, have not shown the same decline. The spread in the business should hence be preserved and entities which are witnessing cost to income ratio decline are in a good position to keep the benefit. Source: Company, ASK Estimates In the above analysis; HDFC Bk, IndusInd Bk and Kotak Bk are considered for Private Banks, Bajaj Finance, Cholamandalam Finance are considered for NBFC while SBI and Bank of Baroda are considered for PSU Banks Technology and reforms have made the addressable space larger: Relatively unbanked areas like micro finance have been the focus on micro finance focussed players for some time. This area has seen good profitability and as the lending size in this area has increased, the profitability has also increased. This space was not very scalable in the past. However, technology and reforms like Aadhar and credit scores is making this space very scalable. Aadhaar implementation has reduced customer acquisition costs and hence banks are not willing to on-board customers hitherto un-served. Increasingly banks are acquiring new customers using Aadhaar based verification. Some micro finance entities have converted themselves into small-banks and some are merging with banks. Reforms have changed the asset allocation of Indians: Indians have been big savers. However, the assets of choice have been real estate and gold. This has changed after demonetization. There is a clear trend towards financialization of savings. Formalisation of economy (led by GST) has ensured that the parallel black economy contracts and force people to move to white economy thus bringing them in to the banking system. Bank deposits increased sharply (though they have normalised since) and flows into both debt and equity mutual funds have sharply risen. It seems country men are correcting their large under allocation to equities in a systematic manner over time. SIPs into equity funds which used to be just about Rs.3000cr a month, two years back are crossing Rs.7000cr a month. Wealth management outfits and AMCs have seen a strong growth in 2
their business and expect the growth to continue in future. Insurance companies are also seeing renewed strength in flows. These are high quality, underpenetrated spaces and growth could continue for a long period of time. Source: AMFI Structure of the market: Financial sector is a space where public sector entities continue to have a dominant presence. However, on account of issues faced over the past few years, the market share of PSUs which used to be over 70% till FY15, has dropped sharply, with private sector accounting for most of the incremental lending. This trend should be expected to continue. This transfer of market share is resulting in overall value creation. Bank index has managed to deliver strong alpha over the Nifty over the past 3 to 4 years even while there have been market share shifts. On account of the above factors we do believe that well run financials which include lending business and fee based businesses like MFs, Private banking, exchanges, rating agencies etc offer probably some of the best opportunities to compound monies over long term. Most of the financial sector stocks are liquid and can absorb large investments, making this space very relevant both to institutional and retail. Our focus on high quality companies and good corporate governance has seen our funds perform relatively well. We have a commitment to remain focussed on the quality space and would remain disciplined. 3
Fund Manager s Commentary Indian Markets were strong in July returning about 6% during the month. With this, except for the Nasdaq, the major Indian indices are the global top performers (7.5% - 10% return) in the current calendar year. The domestic mid and small caps also bounced back, after a weak June, by 3.5% - 4%. Sectorally, oil & gas was the top performing index while Metals was the biggest underperformer. Metals were led down by a concurrent correction in global metal prices which were impacted by weakness in the Chinese currency. A weaker Yuan is expected to weaken global demand for metals. In the current season so far, Indian corporate performance has been robust. In aggregate revenue, operating profits and earnings have been ahead of expectations. So far all sectors, except cement, have reported strong operational growth. High frequency economy indicators continue to strengthen. For June, however, they are partly aided by the GST impacted low base of June 2017. In particular recent months have started seeing a pickup in total and bank credit growth. Within this, demand has been strengthening from retail and service segments. Retail credit demand has been coming from personal loans, credit cards and housing segment. Service segment demand includes demand from trade and NBFCs. On the other hand demand from the industrial segment has still been weak. Our company holdings in the finance sector represent the best business models which are profitably addressing some of these faster growth segments. With over 50% of the monsoon season still left and a marginal short fall of 3% thus far, rural economy should start looking up as the new MSP increases and the impact of farm loan waiver buoy rural demand. Besides rural demand, overall consumer demand should also get boosted in the months ahead as GST rates were cut on 88 items during the month. These items ranged from kitchen /electrical appliances, white goods, paints to sanitary napkins. Across our strategies we have various holdings in many of these categories paints, household electrical appliances, white goods, footwear and sanitary napkins, which will benefit in terms of better demand. Our concept stance of being overweight on the consumption segment should help in the current year as we expect the government to aid consumer sentiment in a pre election scenario. In the recent months, both manufacturing and service PMIs have been improving. Vehicle sales PV, CVs, tractors and two wheelers are growing at low to mid double digit rates on a two year basis (negating for the low base of 2017). During the month, the government relaxed axle over loading /overweight norms. The scope and start point of these norms have not been communicated but will have some impact on short term Heavy Commercial Vehicle demand. However given that overloading is a very common practice in India, the impact is not expected to be meaningful over a medium term basis. We expect the overall strength in the vehicle segment to continue and our strategies have adequate and appropriate representation in this space. Notwithstanding intermittent volatility, we expect a robust underlying economy and corporate sector to present opportunities for investors to participate and compound their wealth. Annual Reports for FY18 have started coming out in the past few weeks. Annual reports for about 60% of the top 500 corporate have been released. Corporate profitability as measured by pre tax ROCEs has inched up from the lows of three years ago to around 13.4%. This has been aided essentially by margin improvement in this period. Asset turns have been stagnant to declining in the last few years. This is not surprising given the impact of GST in FY18 and demonetisation in the year prior. We expect FY19 to see improving revenue growth which in turn will pull up the overall profitability of the corporate sector. Our time tested approach of identifying companies on four value creating pillars should continue to do well in the times ahead. 4
Fund Strategy Growth Fund Our concepts did better than the market. Our holdings in Motherson Sumi rebounded back sharply in the month. Our other holdings in Berger Paints, Reliance, Kaveri and the Bajaj Finance/Finserv did well during the month. During the month we added Dabur while exiting from Ramco and NBCC. Dabur is a market leading player in niche consumer staple (especially herbal based) categories in the country. On the back of this dominance it commands superior profitability. With over 50% of its turnover coming from the rural areas we expect Dabur to be a beneficiary of normal monsoons, rural farm waiver and the strong increase in MSPs for agriculture produce. We had to exit NBCC after a period of relative underperformance from the stock. We exited Ramco, largely a South India based cement player, as in the recent past there have been a large number of new capacities announced in that region. This, despite South India already having +40% unutilised capacity. During the month, the government relaxed axle over loading /overweight norms. The scope and start point of these norms have not been communicated but will have some impact on short term Heavy Commercial Vehicle demand. However given that overloading is a very common practice in India, the impact is not expected to be meaningful over a medium term basis. This development impacted our holding in Ashok Leyland during the month. Otherwise Ashok Leyland has been evolving into a better more diversified firm with operations across most subsidiaries having turned around and its LCV operation in particular doing very well. We expect Ashok Leyland to eventually recover on the back of strong operational performance. We remain vigilant of our holdings and continue to scan the market for opportunities which might benefit the strategies. Life Fund Our fund did better than the market. Our holdings in Balkrishna Tyres, Kansai Nerolac and Motherson Sumi rebounded back sharply in the month. Our other holdings in 3M India, Kaveri and Bajaj Finance did well during the month. With over 50% of the monsoon season still left and a marginal short fall of 3% thus far, rural economy should start looking up as the new MSP increases and the impact of farm loan waiver buoy rural demand. We remain vigilant of our holdings and continue to scan the market for opportunities which might benefit the strategy. Indian Entrepreneur Fund Markets reacted positively to the receding fears of trade wars. However, Nifty with returns of 6% continue to perform better than S&P BSE Midcap Index, which was up 3.6%. Benchmark BSE 500 was up 5.4% during the month. Indian Entrepreneur Fund with its focus on quality businesses that have long runway for growth has continued its outperformance. Key outperformers during the month include Bajaj Finserv, Bajaj Finance and Havells while Cholamandalam Investment and Finance, Minda Industries and Eicher underperformed. Important news during the month include notification from the Ministry of Road Transport and Highways in India revising the maximum safe axle weight of each type for transport vehicles. As per the notification, single axle with four tyres can carry load of upto 11.5-12.5 tons as compared to 10.2 tons earlier while a tandem axle (two axles) for rigid vehicles and trailers can carry load of 21-22 tons as compared to 19 tons as per earlier norms. This can lead to short term pressures on volumes of CV manufacturers and in turn financiers. However, the demand outlook from a 2-3 year perspective remains robust driven by i) Improving macro and pick up in infrastructure activity ii) BSVI pre buying demand. 5
The ongoing result season has been better than estimates. Strategy companies like Bajaj Finance, Bajaj Finserv and Havells in particular have declared very strong set of numbers. Overall, nearly half of the concept companies have declared results so far and the results are encouraging. We continue to believe acceleration in earnings growth for fund companies in FY19. Higher earnings growth coupled with superior business characteristics should help us to remain in good stead. India Select Fund Our fund did better than the market. Our holdings in Motherson Sumi rebounded back sharply in the month. Our other holdings in Asian Paints, Divi s, HDFC Standard Life and Bajaj Finance/Finserv did well during the month. Results from our strategy companies for 3QFY19, except Kajaria, have all been in line with expectations. During the month we exited from Ramco and NBCC. We had to exit NBCC after a period of relative underperformance from the stock. We exited Ramco, largely a South India based cement player, as in the recent past there have been a large number of new capacities announced in that region. This, despite South India already having +40% unutilised capacity. We remain vigilant of our holdings and continue to scan the market for opportunities which might benefit the fund. Disclaimer: This note has been prepared by ASK Investment Managers Private Limited (ASKIM) solely for the information of the clients of ASKIM. While reasonable care has been taken in it's preparation, this report does not purport to be a complete description of the securities, markets, investment philosophy or developments referred to herein and ASKIM does not warrant it's accuracy, completeness or results. The information contained herein may be changed without notice. To the extent permitted by law, ASKIM or its officers, employees or agents may have bought or sold the securities mentioned in this report or may do so in future. This report is not an offer or solicitation of an offer to buy or sell any securities mentioned herein. 6