Seya Industries: Specialty chemical major in making

Seya Industries (Market cap: Rs 1791 crore) is a vertically integrated benzene based specialty chemicals company which is undergoing an expansion plan of global scale. Company’s earnings trajectory, range of products offered and the chemical reaction capabilities highlight the increasing non-commoditised nature of the business, ensuring higher margin profile. Further, it also positions the company as a key beneficiary of the global specialty chemical sector trend of sourcing chemical intermediates from the environmentally compliant hubs in Asia.

Expertise in Nitro chloro benzene/Chloro benzene value chain

Seya was incorporated in 1990 as Sriman Organic Chemical Industries Ltd (SOCIL) with the initial capacity of about 14,400 MT for benzene based chemical intermediates. Its Tarapur plant has the capacity to manufacture 68,600 MT of chemicals in the Nitro chloro benzene (NCB) and Chloro benzene value chain catering to end markets like pigments, pharma, agro-chemicals, rubber chemicals, textiles and personal care.

It caters to marque clients like Bayer, BASF, Atul, Clariant, Sudarshan, Mitsubishi Chemcials, Cappelle, Hindustan Insecticides ltd, Huber group, Chemie and exports to 25 countries.

Seya participates in some categories of NCB/CB value chain

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Source: Aarti industries

Note: A-Chlorination, B-Nitration, C-Ammonolysis, D-Hydrogenation

Table: Installed capacity

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Ambitious capex plans

Seya Industries is undergoing capacity expansion of 443,950 MT (Rs 735 crore) and is expected to commission it in H2 2019. Massive capacity expansion in a similar scale has bee done by Aarti Industries (Rs 900 crore in 2-3 years) speaks about the company’s objective to reach global scale.

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Among the upcoming products, diversification into Sulphur trioxide based specialty chemicals, Thionyl Chloride, Di Methyl Sulphate are noticeable which would have applications in pharma, preservatives in food industry, fabric softners, agrochemicals etc.

Positive industry trends

As pointed by industry leaders, “easternisation” has been a key trend which benefitted chemical intermediate companies of China and India. Easternisation refers to industry wide trend where in chemical majors of developed markets discontinued intermediate process in the chemical value chain and transferred capacities eastwards. It therefore benefitted from resultant asset light structures as well as skilled labour in Asian countries.

In recent years, trend towards environment compliance, need for diversification of country sourcing and favorable competitiveness have benefitted India disproportionally.

Focus on R&D

Seya, with an aim towards scaling the value chain, has maintained a higher run rate for R&D expense compared to the industry leader. Employee cost has surprisingly been kept in check contained. Here, however, there is a possibility for increased allocation as the company undergoes more complex chemistry processes and competes with the global leaders.

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Source: Company filings, moneycontrol.com

Vertical integration remains the key

In an export oriented sub-sector like this, currency remains the key risk. Raw materials are indigenously procured but export competitiveness can be impacted in the scenario of sharp appreciation in local currency. Sourcing risk of raw materials is increasingly covered with the backward integration plans.

Having said that competition from domestic manufacturers and renewal of threat from the Chinese players remain a major risk. Given that possibility, major players in this category like Seya and Aarti are expected to continue to invest in increasing scale and forward integration to value added products.

Financial projections

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In the last three years, company witnessed huge margin expansion (+1294 bps) aided by lower raw material cost (74 percent of sales in FY17 vs. 89 percent of sale in FY 14) and increased contribution of value added products. High margin specialty chemicals constitute 99 percent of sales in FY17 vs. 71 percent in FY14. In the current fiscal operating margins have further improved to about 28 percent. We expect margins to hover at similar level in medium term on account of company’s effort toward vertical integration. Thus, operating profit are expected to witness CAGR of 42 percent during 2017-21E driven by sales CAGR of 37 percent and company’s foray into value added products.

Based on this, the stock is currently trading 13.5x 2020 estimated earnings, which is inexpensive compared to specialty chemical sector average. Further, given the sector wide tailwinds, global scale of operations and foray into value added products, investors can consider Seya industries for accumulation.

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Moneycontrol portfolios outperform benchmarks: Emami replaces ICICI Bank in the defensive portfolio

Moneycontrol wishes our readers a very happy new year! While we are happy to report the out performance in our portfolios, a change in macro call warrants a switch in our portfolio positioning. As the government readies for its last Budget before the 2019 elections, we expect the rural-oriented policies to be the leitmotif. On the other hand, bond yields have been hardening as the market is worried about rising commodity prices and the government overshooting its fiscal deficit target.

Given this backdrop, we have included Emami in our defensive portfolio and dropped ICICI Bank.

Emami is expected to benefit from any increase in rural demand as about 50 percent of its sales are from rural areas. Incentives in the Budget could strengthen  rural demand, which is still recovering from the aftermath of demonetization.

Emami is currently trading 38 times FY19 estimated earnings, a 14 percent discount to market leader HUL. Its earnings are expected to grow at a compounded rate of around 20 percent between FY17 and FY19, driven by double digit volume growth and  improved distribution reach (Direct reach: 12 percent CAGR in 2016-18E ). Further, its presence in high margin categories helps in relatively higher cash yields among FMCG players

Table: Defensive portfolio

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Our defensive portfolio (Inception: 29th Sept) has posted an absolute return of 10.5 percent (vs. 7.3 percent for Nifty).

We are delighted to report the performance of our Diwali portfolio (Inception: 13th Oct 2017) which is a set of high conviction investment ideas, launched during Diwali 2017, and has delivered a handsome return of 26.7 percent (vs. 3.3 percent for Nifty). Further, our portfolio of auto companies which are relatively immune to electric vehicle disruption (Inception: 7th Dec 2017), posted a return of 11.3 percent compared to 5.4 percent by the sectoral benchmark (Nifty Auto).

Table: Diwali portfolio

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Table: EV portfolio

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What to buy in a year of populism, fiscal expansion and possibly rising rates

Moneycontrol Research

The year 2017 was nothing short of a dream run for equities. Almost every global market had a positive close. At home, the Nifty gained close to 30 percent in local currency and 38 percent in dollar terms. The Nifty Midcap 100 Index was up 44 percent and the Nifty Smallcap 250 Index was up 53 percent, all courtesy the highest-ever investments by mutual funds and supportive global portfolio flows.

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The primary market buzzed with 120-odd initial public offerings, picking up Rs 750 billion in subscriptions. Similar euphoria was visible in other markets, driven by high liquidity and a growth recovery in developed countries. The US economy is humming along in top gear, Japan has seen its best growth in two decades and the European Union is enjoying its best economic growth since the global financial crisis.

Year of elevated valuation

However, the growth engine was in slow gear in India. Between Q2FY17 and Q2FY18 the Nifty’s earnings rose by 5.5 percent. As a result Nifty is trading at trailing price-earnings ratio of over 26 times, while mid- and small- caps are trading at PEs above 35 and 53 times, respectively. Hope of a rebound in earnings have attracted more funds into the markets.

The themes for 2018

As we attempt to crystal-ball gaze at 2018, three key themes beckon our attention. Politics will take centrestage as the ruling Bharatiya Janata Party gears up for Lok Sabha election in 2019. Eight states – Karnataka, Chattisgarh, Madhya Pradesh, Rajasthan, Meghalaya, Nagaland, Tripura and Mizoram are to hold assembly elections.

The imperative of electoral victory coupled with the need to plug the absence of private capex and an expansionary fiscal policy will be another hall mark of 2018.

A global recovery and firmer commodity prices including crude and expansionary fiscal policy are all pointing to hardening rates – our third theme for 2018.

Rural pump-priming in focus – consumption to gain

Given the strategic importance of rural economics to India’s political economy, we see a very high likelihood of policy action aimed at addressing the unbalanced terms of trade that have shifted against rural India.

In our view, the stress in the farming economy has reached a level where near-term solutions may be needed including a modest fiscal response and pump-priming of the rural economy.

Policy needs to recalibrate the challenge of keeping inflation under check but without making farming non-remunerative. A calibrated increase of MSPs (minimum support prices) over the next three years to a level which takes margins higher may be needed.

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Historically, in years when the government has taken steps to mitigate pain in rural sector, say in form of higher MSP, sectors like consumer staples have responded positively and outperformed the broader benchmark.

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Source: Ace equity, moneycontrol, Reuters

A spur in demand on account of similar measures in future can aid FMCG sector companies having a higher rural India exposure. HUL and Emami are among those having 40 to 50 percent share of sales from rural region with a well-entrenched distribution network and an increasing contribution from direct reach vs. wholesale. We see companies like Dabur and Manpasand Beverages getting positively impacted.

The other consumption category to benefit would be entry-level electricals and brown good makers like Bajaj Electricals, Havells, CG Consumers, Veto Switchgear, V Guard, Dixon Technologies, TTK Prestige, Hawkins, Butterfly Gandhimati Appliance etc. Higher purchasing power should impact jewellery companies like PC Jeweller and Thangamayil Jeweller.

The strength in the rural economy will also boost demand for two-wheelers (2W) and four-wheelers (4W) and help companies like Hero MotoCorp in the 2W segment and Maruti Suzuki and M&M in the 4W segment.

Housing for all by 2022 is definitely a pet project of the government that should continue to get disproportionate attention. Rural housing forms 40 percent of overall cement sales in India, which is largely supported by agricultural income and rural wages. We see gains coming for cement, asbestos and housing finance companies and identify HIL, Visaka Industries, NCL Industries, Sintex Plastics, Star Cement, JK Cement, Dalmia Bharat, and Ultratech. The financiers to participate in the theme are the likes of Gruh Finance and Repco.

Improve farm productivity and raise farm income

Another issue that could merit the government’s attention is fragmented land holdings, which depress productivity and prevent mechanisation. The Modi administration has articulated its strong commitment to doubling agriculture incomes by 2022. However, the strategic quest to double farmer incomes cannot be successful until all state governments cooperate, as agriculture constitutes a state subject. Given the significant benefits of this initiative in improving farmer incomes, the central government may not be averse to amending laws that override the state APMC (Agricultural produce market committee) laws, creating a national common market for agriculture.

Any move in this direction will aid companies that are involved in farm mechanisation and improving productivity. The list is long and the prominent names are M&M, Escorts, Swaraj Engines, Shakti Pumps, VST Tillers, Coromandel, Rallis, Finolex Industries, Jain Irrigation, Garware Wall Ropes, Kaveri Seeds. The finance companies to benefit are M&M Finance, Muthoot Finance, and Shriram City Union, with a significant rural presence.

While FDI in multi-brand retail has been a contentious issue, it has the potential to significantly enhance agricultural incomes by allowing farmers to sell directly to retail chains. It will also result in a potentially explosive increase in demand for supply chain infrastructure which will be beneficial for large as well as small and medium enterprises. The move could be very significant in terms of job creation, given the wide linkages across the supply chain, from farm to fork.

One of the expected focus areas for the government is also to address the farm-to-consumer value chain so as to increase additional avenues for farm income, lower food wastage and improved infrastructure. Among staples, ITC seems better positioned in this value chain of farm sourcing and processing and could be a preferred company to look at.

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Source: Ministry of Food Processing industries

Fund allocation for food processing industries has increased in recent years with focus on infrastructure (food parks, cold storage chains, food processing industries). While some of the unlisted players like Patanjali are expected to benefit in particular, the category itself is expected to expand from here.

Companies from the farm allied sectors like animal feed and dairy could benefit from the government’s thrust towards doubling farm income by 2022. Investors should keep Avanti Feeds, Godrej Agrovet, Apex Frozen Foods, Parag Milk Foods on their radar.

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Benefits from DBT to be channelled to rural infrastructure

DBT (direct benefit transfer) could help the government achieve considerable savings on account of fixing leakages, with saved funds channelised towards higher expenditure on roads and railways and increasing allocation towards quality of life issues – sanitation, healthcare and water. A look at year-wise progress shows that the amount of funds disbursed under DBT has increased year after year.

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Capex – revival in selective pockets

While overall the private capex cycle will remain a non-starter in 2018, we definitely expect government-led capex to continue, led by rural infrastructure, roads and railways.

To play the theme we like Dilip Buildcon and Titagarh, which are relatively strong in terms of earnings visibility and capabilities. Further downstream, we also like Tata Steel, which has got strong distribution network and branded retail products, and so would be the largest beneficiary.

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In power, more than generation, T&D (transmission and distribution) sector will be in focus with the government augmenting the T&D capacity to evacuate power. That apart, the focus is on connecting the rural markets with the grid and providing excess of power to deprived regions and villages. The government recently announced it would electrify all the villages by the end of December 2018 with an  outlay of Rs 16,320 crore. It is expected that the implementation of Soubhagya, the scheme to electrify all villages, could lead to an additional demand for 25,000 MW of power. We expect companies like Rural Electrification Corporation, ABB, KEC International and Voltamp to benefit.

What to avoid in 2018?

We would avoid companies with excessive leverage. For financials while the hardening yields do not spell good news for wholesale financing companies, we would avoid entities earning thin spreads and stick to a handful of rural focused differentiated asset financing companies as mentioned above. For public sector banks, in is a tale of two halves with the stronger ones likely to get capital, but the end of the NPA resolution is still a year away, so patience is warranted. Efficient private banks will continue to garner market share and will have their evergreen appeal.

We are a bit circumspect on the oil marketing companies, given the inflationary headwinds. For upstream companies crude remains a joker in the pack too as a sharp rally may bring back the ghost of subsidies.

Export-oriented sectors – be selective

Turning to the defensives, we continue to remain positive on the auto ancillary sector given the secular growth outlook for the automobile sector. However, we are turning more selective in light of the impending disruptions from electric vehicles. Names like Motherson Sumi, Jamna Auto, Lumax Industries, Minda Corp, PPAP Automotive, and Gabriel India lend comfort.

With increasing pace of approval from US FDA, the outlook for pharma companies is definitely looking better, although a regulatory hangover with respect to US FDA clearances of Indian facilities remain. We are selectively positive on the space with names like Sun Pharmaceuticals, Cadila and Torrent.

Information technonogy is undergoing a painful technological transition and will produce only a few winners in the long run. Our preferred bets in the sectors are the companies that we see weathering the storm like Cyient, Mindtree and L&T Infotech.

Overall, we see challenges in the heady earnings growth of the broad index and would monitor this closely.

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While we expect modest return from broad markets, we definitely see pockets of excellence outside of the broad headline index. Do stay tuned to Moneycontrol Research for all our “alpha generating” ideas through the year. Wishing you all a great year of rewarding investments.

Thirumalai Chemicals: Exposure to varied markets, capacity expansion & diversification key triggers

Thirumalai Chemicals (Market cap: Rs 2226 cr) is the second‐largest manufacturer in the domestic phthalic anhydride (PAN) market after IG Petrochemicals. Phthalic anhydride is an ingredient for PVC (Poly Vinyl Chloride) and is also used in construction and electrical insulations. Further, Thirumalai’s value‐added product portfolio such as maleic anhydride (MAN), diethyl phthalate (DEP), and food acids has steady  demand from the food and beverage, cosmetics, animal feed industries.

The company’s strong presence in a duopoly market (phthalic anhydride), a portfolio of value added products, capacity expansion plans and a healthy balance sheet makes it an interesting business to look at.

Phthalic Anhydride – Value chain

Phthalic anhydride (91 percent of FY 2017 standalone sales) is a downstream chemical, derived from oil derivative ortho xylene, used for the production of plasticizers, paints, pigments etc. Plasticizers, in turn are used in the production of polyvinyl chloride (PVC) and accounts for the majority of PAN demand.

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Net import trends – domestic supply tightness

Phthalic anhydride’s domestic market size is about 350,000 MT, wherein Thirumalai Chemicals and I G Petrochemicals cater to more than 3/4th of the domestic requirements. Recently phthalic anhydride imports have significantly risen (33 percent CAGR 2015-17) and currently about 20 percent of demand is met through net imports. Further, capacity shutdown by Asian Paints (29,796 MT) in early FY 18 has added to the tightness in domestic supply tightness.

This provides an opportunity for existing Indian manufacturers to expand capacity.

Table: Phthalic Anhydride demand supply

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Source: Ministry of Commerce, Ministry of Chemicals, Moneycontrol research

Additional capacity expansion

Thirumalai Chemicals (PAN capacity of 140,000 MT) is adding 60,000 MT of capacity in Dahej. It’s first phase is expected to be completed in 2019.

Further, the company has recently increased its food ingredients and fine chemicals production capacity by 40 percent and expects to ramp up  capacity further in the current year (funded by internal accruals).

Extra leg of growth from the Malaysian subsidiary

Its Malaysian subsidiary, Optimistic Organic (~18 percent of FY 2017 consol. sales), has expanded the capacity of maleic anhydride to 45,000 MT (from 42,000 MT) in FY 17. Optimistic Organic is also establishing food ingredients and fine chemicals plants in Malaysia based on Thirumalai Chemicals’s technology.

Optimistic had to occasionally shut down plants for expanding capacity, leading to production losses. However, going forward, Thirumalai expects improved profitability from its Malaysian subsidiary as  production stabilizes.

Interestingly, India itself is an important market for Malaysian operations as India imports majority of its requirement of maleic anhydride (market size: 52,000 MT) due to unavailability of raw material (En-Butene).

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Improving return ratios

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Source: Ace equity

The key reason for improving return ratios is subdued raw material prices (orthoxylene). Phthalic anhydride prices have also eased over the years, but companies in this segment have not passed on the full benefit to consumers. This indicates some pricing power as demand for phthalic anhydride has also risen.

The biggest use of ortho xylene (roughly 90 percent) is in the manufacture of phthalic anhydride . Typically, one ton of ortho xylene is required to produce about 1.08 ton of phthalic anhydride.  India has a huge surplus capacity for ortho xylene after taking into account domestic production of phthalic anhydride.  So medium term phthalic anhydride expansion plans of the industry (113,000 MT additional capacity) is well covered.

Infact, RIL has 562,000 MT installed capacity for ortho xylene and is one of the biggest producer of ortho xylene in the world.

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Financials and valuations

Near term sales volume growth is expected to come from increased capacity for food acids, fine chemicals and the improved operations from Malaysian subsidiary.

In the medium term, company’s major volume growth is expected to come the expanded capacity for phthalic anhydride becomes operational.

Margin tailwinds are expected to continue, benefiting from subdued ortho xylene prices and improving demand scenario for phthalic anhydride. Further, company’s exposure to food acids, fine chemicals are expected to aid overall margins, as well.

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Currently the stock is trading at a multiple of 13.8 times estimated 2019 earnings, which is reasonable and at a discount compared to peers in the chemical universe. Its significant presence in a key chemical intermediate and attempts to scale up the products value chain, positions it for a better margin profile which investors can consider.

Prataap Snacks Q2: Solid bottom-line show, but competition needs to be watched

Since its IPO listing, Prataap Snacks has nudged further about 10 percent after a listing gain of 33 percent. While it continues to ride on volume led India consumption growth in snacks industry, its recent result highlight improved operational performance. However, intense competition in the snacks industry, elevated valuation and the vagaries of the raw material costs make us wary about listed entities in this space.

Stellar quarterly result 

Prataap Snacks posted robust result with a sequential improvement in sales. In case of gross margins, there was a 688 bps (YoY) improvement on account of favorable raw material costs (64 percent of sales vs. 69 percent in Q2 FY17), rationalization of trade margins and better product mix. EBITDA margins expanded 528 bps as higher employee costs were more than offset by lower finance costs and moderation in other expenses. Consequently, net profit jumped more than two times.

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Nearest peer DFM foods also registered decent growth

DFM foods quarterly result also showed a traction in sales (+20 percent YoY) and margin (EBITDA margin: +305 bps YoY). Company’s EBITDA margin at ~13 percent is still well ahead that of Prataap Snacks (9.9 percent).

DFM Foods benefitted from seasonality (school reopening), lower base and change in distribution strategy for regions other than North India.

IPO funds utilization

Prataap received net IPO proceeds of Rs 236.2 crore after deducting IPO expenses. The company had earlier marked Rs 50.98 crore for the repayment of borrowings, of which Rs 37 crore has already been utilized. Currently, company’s long term debt is about Rs 17.18 crore.

Higher share in urban market and improved capacity utilization to derive from volumes

The company’s next leg of growth is expected to come from improved presence in tier 1 cities. Adding to that new product launches would be handy. Capacity utilization till end of FY17 was in the upper band for most of the plants except for the Guwahati plants for “Chulbule” and pellets. We expect that better utilization in these plants can add about 5-6 percent to production volume in the near-term. The company also envisages further capacity expansion through IPO proceeds (Rs 67 crore).

In similar strategy, company’s nearest competitor, DFM Foods has recently completed a brownfield expansion leading to total capacity of 26,000 MT (from 16,000 MT) at a project cost of about Rs 62 crore. Further, it is looking for greenfield expansion in Pune to better serve western region.

Financials and valuation

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Based on company’s H1 2018 results and better capacity utilization, we have made changes on the financial projections. Stock is currently trading at 57x 2019e earnings which is similar to its peers in snacks industry but ahead of the consumer staples price multiple (GICS average: 45x 2019e Earnings).

In the near-term, raw material costs remain the key variable to watch, in light of supply concerns emerging for potatoes. Further, intense competition in the urban snacks industry might make it a challenge.

The company’s entry in to the sweet snacks category through the launch of Yum-Pie needs to be tracked closely as well. It can possibly get some traction on account of pricing strategy and focus on tier 2 cities/hinterland, just as in the case of savoury segment. This category is otherwise getting contested by large players like Lottee and ITC, particularly, in tier 1 cities.

Gujarat Election marks a subtle change in outlook – how to play the change?

The Gujarat election results came as a surprise after the near consensus pointing to a big victory for the incumbent Bharatiya Janata Party (BJP). With several state elections lined up and the big general election of 2019 to follow, markets cannot afford to take their eyes off politics in 2018. Brace for higher doses of populism in the upcoming budget which might benefit consumption but would certainly not be positive for interest rates and the investment cycle.

Rural India is likely to remain a focus for the forthcoming Budget with a clear eye on the vote bank. So the populism that started with a loan waiver is likely to be followed up with lot more in the days to come.

The near certainty on the political front after the UP electoral victory has got a jolt, so expect FY19 to be a rather slow year as any big bang reforms will have to wait till Election 2019.

While markets have shrugged off the worries, going forward, the tweak in policy consequent to the narrow margin of victory beckons attention. We at Moneycontrol Research recommend investors to look at a gild-edged portfolio of ten very high quality businesses that are ideally suited for a risk-averse investor.

 

Bharat Forge (BFL), a technology-driven metal forging company having a transcontinental presence, posted a strong set of numbers for the second quarter ended September 2017. BFL posted a significant growth in revenues riding on its performance in both the exports and domestic market. Consequently, margins also witnessed an expansion. The positive outlook for industrials and Class 8 truck demand in the United States and multiple growth avenues make it an ideal investment call.

Cochin Shipyard

The state-run Cochin Shipyard has very little balance sheet risk with cash in the books and consistently delivering growth and good return ratios. Moreover, the company is now investing this cash, close to Rs 2,700 crore (including the IPO money) or about 37 percent of its current market capitalisation, building capacities particularly in ship repair, a fast-growing segment accounting for relatively high margins. Moreover additional resources will help in faster execution of orders with order book of close to Rs 8,300 crore or about 4 times its sales.

 

Cyient

In the IT space, we like Cyient as it has a large exposure (about 54 percent) to relatively under-penetrated engineering services, and strong client relationships. It has least exposure to US H-1B visas and is relatively immune to the difficult transition that the traditional IT companies are undergoing.

Hindustan Unilever (HUL)

In its last quarterly result, improvement in volume growth (4 percent) was broad-based with rural areas benefiting from two consecutive normal monsoons. HUL, with its high rural exposure (40 percent of sales) is among the key beneficiaries of a further uptick in consumption and related policy announcements. Further, HUL also gains from the GST rate cuts (18 percent from 28 percent) in the home and personal care category, aiding volume traction.

Kotak Bank

Adequate capital and a robust liability franchise should help profitability as it presses on the growth accelerator. With the recent equity infusion (INR58bn), the bank is likely to play a meaningful role as a buyer in the distressed asset space. The shift in savings pattern of Indians from physical to financial augurs well for the financial conglomerate.

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Motherson Sumi Systems

Motherson Sumi Systems (MSSL) is India’s largest automotive wiring harness company and one of the largest auto ancillary companies.  It is commissioning new plants that should result in increasing operating leverage. This, coupled with the push towards EV (Electric Vehicles) should result in healthy growth in the top line and gradual increase in margins. MSSL is currently trading at reasonable valuations, which warrants investors’ attention.

NBCC

NBCC, which is into the construction of government projects, has strong earnings visibility with the company sitting on an order book of close to Rs 75,000 crore or 12 times its trailing revenue. What is more, with one of the best returns on equity in the industry and zero debt in the books, NBCC could be the best one to ride volatility.

Petronet LNG (PLNG)

With renegotiation of Gorgon LNG contracts, continued shortage of LNG, capacity expansion at Dahej, resuming of operations at Dabhol, full commissioning of Kochi terminal scheduled by December 18 and rising crude oil prices, we see a future uptick in volumes and positive movement for the stock. The stock is currently trading at a FY19 PE of 16x which is in line with the industry average.

Reliance Industries (RIL)

Standing at the end of an aggressive capex cycle, RIL is positioned for to gain from operational efficiencies. With most projects stabilizing and with increased focus on Jio along with a possible spin off, we see stock rerating and upside. We expect resumption of the oil marketing business to bring greater vertical integration which would lead to better margins in the coming quarters.

Sun Pharma

Sun Pharma is in the midst of a painful adjustment with pricing pressure in US generics business and a key plant catering to US markets under US FDA (food and drug administration) scanner. While FY18 is going to be a difficult year, its investment in speciality business should start bearing fruits from FY20.

Fed’s Dec meeting: Market not factoring Fed projections for 3 rate hikes in 2018

The US Fed’s December meeting decision was on expected lines. The change in dynamics this time around is the improved growth prospects on account of tax changes and market’s expectations for fewer rate hikes next year. Should markets catch up with Fed’s expectations as they did in 2017 when owing to higher yields in US, fund flows headed back?

Dot plot: Three rate hikes in 2018 expected

As expected, Federal Reserve has increased the funds rate by 25 bps, thus moving the target range for the federal funds rate to 1.25 to 1.5 percent. This is the fifth such rate hike in this interest rate normalization cycle. As per Federal Reserve dot plot, median expectations remains for about three rate hikes in 2018 and two/three in 2019.

Federal Reserve expects a gradual increase in policy rate to continue till it reaches a neutral rate, which in itself is expected to remain lower than the levels prevailed in previous decades.

Federal Reserve: Dot plot

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Growth expectations

The Federal Reserve has changed the growth forecast for the near and medium term. Particularly, for next year, growth projection (real GDP) is 2.5 percent (from 2.1 percent in September 2017). Improved GDP growth outlook is attributed to the expected changes in tax code. Additional improvement is seen for unemployment numbers which is expected to be about 3.9 percent in 2018.

However, inflation numbers are essentially same. Core inflation (excluding food and energy) was 1.4 percent in October.  FOMC continues to believe that current year’s inflation softness reflects transitory developments that are largely unrelated to broader economic conditions; hence, it is expected to reach 2 percent in the medium term (by 2019).

Table: Economic projections of Federal Reserve Board members

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Balance sheet normalization

Balance sheet normalization process remains as expected but with a rider that if there is material deterioration in the economic outlook, reinvestment can resume.

Change in language for labour market

The Federal Reserve mentioned that there is a change in the statement’s language for the labor market. While FOMC considers labor as strong, it expects the pace of job gains to moderate over time as it gradually reduces the degree of monetary policy accommodation.

Two dissenting votes

Voting against the action were Charles L Evans and Neel Kashkari, who preferred at this meeting to keep status quo, probably given the subdued inflation numbers.

Market’s implied probability for 2 rate hikes in 2018

While median projections are for 3  rate hikes next year, the market implied probability for fed futures suggests two rate hikes with ~60 percent probability for a rate hike in March. So, clearly, the market remains cautious and keeps a relatively dovish expectation during Jerome Powell’s regime.

However, that said, prospects of huge repatriation of fund flows due to tax code changes and a continued rise in policy rate have kept the other central banks on the edge.

For instance, China’s central bank has modestly increased the borrowing cost (+5 bps) to provide reasonable expectations for interest rates and prevent financial institutions from adding excessive leverage and expanding broad credit supply, as per PBOC.

Real interest rate differential is worth a look

In this context, other central bank meetings become an interesting set of events to look at in this global interest rate normalization period. Another trend to look at is interest rate differentials which has in recent times remained favorable for India but this can change soon. Particularly, when inflation is inching up in India, real interest rate differential may not be favourable in times to come.

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