Author: anubhavsays

Early Diwali for Future Retail & Shoppers Stop as HyperCity changes hands

One of the biggest deals in the retail space got announced with Kishore Biyani’s Future Retail deciding to acquire Shoppers Stop’s HyperCity arm. The transaction value, pegged at Rs 655 crore, will be paid by Future Retail through allotment of shares worth Rs 500 crore to HyperCity’s existing shareholders, in addition to Rs 155 crore in cash.

While the deal value, prima facie, looks muted, Shoppers Stop gets rid of a pain point and can focus on maximizing gains from its relationship with Amazon. For Future Retail, 1.3 million square feet addition (close to 30 percent of Future Retail’s existing area) helps it to augment capacity in one stroke and position its offerings in a premium format, thereby paving the way for a speedier turnaround of beleaguered HyperCity.

Deal contours

In its intimation to BSE, Future Retail laid down the contours of the agreement. The equity aspect includes issue and allotment of 9,310,987 shares (1.9 percent of Future Retail’s share capital) at a price of Rs 535 per share, amounting to Rs 498 crore. HyperCity’s debt, amounting to Rs 265 crore, would be transferred to Future Retail. After making adjustments for cash and cash equivalents, the enterprise value of HyperCity is roughly Rs 916 crore, implying an EV/Sales multiple of 0.79.

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While the deal value is at a discount to the valuation of Future Retail (1.57x EV/Sales) and Shoppers Stop (0.98x EV/Sales), as stated in detail in an earlier article, both companies stand to benefit by virtue of this development.

Shoppers Stop gets a clear roadmap

With HyperCity now off its books, Shoppers Stop’s efforts will be solely directed at its forte of retailing home accessories and apparel. Furthermore, the recent tie-up with Amazon will enable Shoppers Stop to enhance its online brand visibility, among the other benefits, as stated in one of our previous reports.

The retail major’s consolidated financials that were negatively impacted by HyperCity’s performance over the years, could witness some relief on back of better EBITDA (a negative EBITDA business segment will no longer be a drag) and bottom-line margins (debt repayment to be effected through proceeds received from sale of HyperCity and investments from Amazon).

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Amazon’s hunt for a grocery partner continues

While Amazon succeeded in joining hands with Shoppers Stop to build its brick and mortar store presence across India, they are likely to leverage this relationship in product categories that are closely identified with Shoppers Stop.

Amazon has been scouting for a partner for foraying into food and grocery retailing, and it may be interesting to see who fits their bill.

HyperCity could turn out to be the premium/differentiated format for Future Retail

HyperCity’s impetus is clearly greater on metros catering to the upwardly mobile population, whereas Big Bazaar, the flagship brand of Future Retail, is oriented towards the mass affluent category. The product categories and pricing of these two formats are different.

The cash outgo for the deal is only Rs 155 crore and Future Retail can fund this easily from its internal sources without resorting to additional debt.

While it is premature to put a timeline on the turnaround of HyperCity, Biyani has his plans chalked out to make the deal value accretive for the shareholders early.

The best practices adopted in its existing retail formats would find application in HyperCity as well. Future Retail’s plan is to rename a few HyperCity stores to Big Bazaar Gen Nxt in the immediate future owing to a good brand following in the case of the latter. Secondly, the company aims to actively commence Fashion Big Bazaar sales from the remaining HyperCity stores to cash in on the growth prospects in the value fashion segment.

Krishna Karwa & Anubhav Sahu

Moneycontrol Research

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Prataap Snacks: Do some peers provide a better value and growth mix?

The IPO of Prataap Snacks introduces us to a debate on pricing in the investment circle. While the company could possibly be an investment proxy for the snacks consumption demand in the hinterland, a pertinent question is on whether the pricing is justified. If not, are there investment alternatives in the same space that makes a better sense both in terms of valuation and strategy?

Distribution and value leverage

Prataap Snacks’ above-industry sales growth has been a product of distribution strategy and value proposition. While executing its distribution strategy, company tapped unorganized grocery stores from Tier 2 cities and towns and focused on smaller SKU (stock-keeping unit) products (Rs 5) for a wider acceptability.

It’s comparable in the snacks and beverage segment. Manpasand Beverages benefited from the volume uptick in lower value products (60 percent of the sales from Rs 5, Rs 10 and Rs 15 SKUs). In terms of distribution, Manpasand already has a tie-up with IRCTC for direct selling to vendors. Besides, the company recently inked a deal with Parle products to leverage their distribution network (5.5 million outlets). It not only helps to cultivate a Pan-India presence quickly but also establish product positioning in early days.

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Prataap Snacks, while being a formidable player in rural areas and small towns, has a relatively limited presence in the tier 1 cities, for which it may have to look for new channels of distribution.

Growing competition

The snacks and beverage segment is witnessing intense competition.  Existing FMCG players like DaburITCcontinue to bring products in non-carbonated beverages range. Manpasand Beverages is also expanding its product offerings.

In the snacks segment, the RP Goenka group recently bought a controlling stake in packaged foods company Apricot Foods (E-Vita brand). Interestingly, this company produces snacks priced at Rs 5 per pack with an annual turnover of Rs 200 crore.

DFM Foods has also launched low priced SKUs recently. Thus, while competition is increasing, proven market strategies for market share expansion is also getting replicated.

Higher brand promotion costs

Brand recall could be one of the differentiating factors in this space. Various companies in this segment, preempting the requirements, have roped in celebrities and kept a substantial budget for selling and marketing expenditure. While this is necessary, striking a balance with other cost overheads is important.

While peer names like DFM Foods and Manpasand Beverages have maintained a double-digit operating profit, Prataap Snacks posted mid-single-digit numbers. As a corollary to the low-cost strategy, its raw material cost-to-sales ratio at 71 percent stands out and could be vulnerable in an inflationary environment.

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Volume growth and capacity expansion

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Key players in this segment are ramping up the production capacity. Prataap Snacks would utilize a part of its IPO proceeds for the 50 percent expansion of the potato chips plant. Manpasand is doubling its production capacity with three new units at Vadodara, Varanasi and Sri City. DFM Foods is executing a brownfield expansion of 10,000 MT.

Valuation: How are competitors stacked up?

Prataap Snacks earnings multiple, implied from the IPO price band, is quite elevated. Even if we normalize the valuation multiple as per FY16 show, when the performance was not impacted by demonetization effects and higher market costs, valuation comes in at 54x 2017 earnings.

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After factoring capacity expansion plans (at the same capacity utilization) and the resultant earnings growth, PEG ratios are strikingly different. Manpasand Beverages is at a more reasonable multiple. This can further improve if the company is able to improve capacity utilization (currently at 54 percent).

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*Normalised PE ratio for Prataap Snacks

^Capacity expansion completed in two years and taking a 5  percent pricing effect

So, while Prataap Snacks has impeccably executed the strategy to win market share in the hinterland, the coming days would be quite competitive, more so as it moves up the value chain of both products and the market.

Given the distribution and capacity expansion plans, its peers like Manpasand Beverages appear much more reasonably priced. Overall in the consumption space, it makes a credible investment rationale if one looks at the alternatives that are better priced and offering higher return on equity.

Amazon’s slice-and-dice distribution offerings to see many more tie-ups

The penchant of Amazon to venture into brick and mortar business prima facie looks counter-intuitive. For a consumer-facing company like Amazon, superior customer experience is what matters and hence the foray into brick and mortar format comes as a logical extension.

In the US market, a glimpse of this strategy was visible when Amazon acquired Whole Foods. However, the global e-commerce giant has adopted a smarter strategy in India so far wherein it has picked up a small stake in Shoppers Stop. But Amazon continues to be in the news on tie-ups and partnerships as it tries to service each and every micro market well. It is relentlessly trying to customise its offering by mapping suppliers with the end user segment in its e-commerce platform.

While its recent partnership with Dabur whereby the Indian FMCG major will get to sell its Ayurvedic products through Amazon’s market place in North America is a case in point, we feel it is just the beginning for Amazon. So watch this space.

Global e-commerce platform provides an easy reach for FMCG players

Global e-commerce has picked up in the last few years, primed by platforms like Amazon’s global market place, Alibaba’s Tmall Global and JD Worldwide. Amazon’s global market place, in particular, has made a mark for itself by helping local sellers sell on global locations through its platform. Its global selling programme, launched in 2015, has attracted interest from more than 25,000 Indian sellers.

Amazon has recently inked deals with FMCG players for selling their products in international locations and hence providing distribution advantage. Companies like Patanjali, Godrej Consumer, Marico have been selling their products in the US website of Amazon.

In the case of arrangement between Amazon and Dabur, the latter’s products would be sold in USA, Mexico and Canada through Amazon’s platform. Dabur has about 31 percent of sales (Q1 FY2018) from international markets and this would help increase the reach of company’s Ayurvedic products internationally.

Patanjali products in Amazon.com (USA)

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Digital medium gets centre stage for certain end users

Recently, FMCG players have clinched exclusive deals with the online marketplace aiming at capturing certain clientele and distribution reach with differentiated product offerings. Nestle recently launched its new range of Maggi noodles, Nutri Licious, at Amazon before anywhere else. The company’s objective was to address consumer segments like millennials who are more inclined to purchases online. Media campaigns by the company are also skewed towards digital channels for the products popular among youngsters. Nestle recently launched Kit Kat dessert at another e-commerce platform – Big Basket.

Amazon is also adopting a strategy whereby on one hand it is making a global platform accessible to local sellers; on the other hand, it is helping local sellers customise their offerings in their local market.

Brick and mortar forays for grocery retailing

That said, Amazon has of late realized the importance of the brick-and-mortar format as well to cater to certain product categories requiring consumer experience and convenience. The Amazon Go store concept in the US is one such attempt, wherein consumers avail a hassle-free shopping experience.

Indian experience:  Online and offline combo

Amazon’s acquisition of Whole Foods was another big move to foray into food retailing. Some of the Whole Foods products are now cheaper by 40 percent. Indian markets was also expecting a disruptive strategy from Amazon in the food grocery market. However, instead of waiting to execute an M&A transaction in this space (eg: Big Basket), the company opted for a minority stake purchase (5 percent) in Shoppers Stop. As we mentioned in our previous article, Amazon could use this opportunity to expand its reach in the grocery segment through Hypercity.

In the perishable goods and grocery market, it may help to provide product experience to customers through such brick and mortar outlets. This dual combination of offline and online channel is gradually picking up. Existing retailers having brick and mortar formats like DMart have recently started with their online version – DMart Ready. Similarly, Tata Group has announced online grocery business (Starquik brand) channel for Trent hypermart.

In case of Amazon, small ticket investments in retail formats helps in gaining benefits of brick and mortar format without investing heavily, particularly, when they are still experimenting various modes of reaching out to consumers. In this context, it may not be surprising if Amazon reaches out to other major brick and mortar retailers like V-mart to penetrate into tier 2 cities and towns.

Overall, Amazon is banking on multiple levers to expand its reach. Hence, retail as well as FMCG players will see much more action in the coming days as the offline-online partnership gathers momentum.

Paints cos’ fortunes under strain from trifecta of oil, China shutdowns & lower rupee

Prices of titanium di oxide (TiO2), the key raw material for paints, is firming up again on account of capacity shutdowns in China. Along with this, oil prices have added to the margin pressure for paint companies. Further, currency depreciation is also not helpful. In light of this, paint companies might face further margin headwinds.

TiO2 – A market with limited supply

Titanium di oxide (TiO2) is a white powder pigment having its main application in paints, paper and plastics as it imparts whiteness and opacity to the final products. After the industry witnessed a recent consolidation, key manufacturers constitute 62 percent of the total production. That said, the bulk of the production share comes from small manufacturers based out of China. Recently, with China shutting down a number of companies on account of environmental concerns has led to supply constraints in the global TiO2 market.

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Source: Cristal.com

Major manufacturers 

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Source: Venator

TiO2 prices

Along with the tightening of supplies following China closing down its companies, spot prices of TiO2 have started firming up recently.

TiO2 prices had earlier declined due to increased inventory levels and weaker domestic demand. However, a combined effect of more shutdowns of TiO2 production plants globally, raw material supply constraints (Ilmenite/rutile mineral ores and pet coke) are causing an uptick in prices.

China Titanium di oxide prices trend (USD/tonne)

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Source: ICIS

Additional Chinese TiO2 capacity cut-down in the offing?

China is the second largest exporter of TiO2 pigments constituting 22 percent of global TiO2 export share (CY 2016) and therefore shutdown of facilities in China creates a global shortage. As per Ventator Corp, leading producer of TiO2, there have been 400k MT capacity cut-backs in China during the period 2015-17. In the near-term, further closure of 200k MT capacity is expected amounting to 3.3 percent of global demand (estimated 6155k MT in 2017).

TZMI, a management consultancy firm, estimates that TiO2 inventory in the value chain would be depleted by end of 2017 and hence the overall market would remain tight until new capacity comes in. Ventator mentions that it takes about 3-4 years for the new capacity to come online.

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Source: Venator, TZMI

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Source: Trade map

In case of India, China’s contribution to our TiO2 imports have already shrunk in the first half of 2017. In H2 2016, China constituted 35 percent of total imports of TiO2 pigments in India which has reduced to 28 percent in H1 2017 (data till May 2017).

Not surprisingly, TiO2 price quotation from the sole manufacturer in India, Kerala Minerals & Metals (Kerala Govt. undertaking) is at Rs 205/kg which is 25 percent higher than the local price prevailing 12 months ago.

Pet coke price increase also impacts the TiO2 price

Pet coke prices, a key raw material used for the manufacturing of TiO2, has also firmed up. Chinese coke price is up 14 percent in last one month resulting in a raw material price increase for TiO2 production.

Chinese pet coke price trend

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Source: sunsirs

Paint companies bear the cost pressure

TiO2 prices (~50 percent of the raw material cost) are not the only raw material prices which are of concern for paints companies. Surge in oil prices have increased the prices of oil derivative solvent prices as well. Cost pressures in the last one year have already impacted margins. Aggregate EBIDTA margin of paints companies at 18.9 percent has contracted by more than 300 bps on YoY basis.

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Source: Capitaline

Asian Paints, in the last quarterly conference call, mentioned that it doesn’t expect any substantial easing of TiO2 prices and supply tightness in this segment is expected to remain in near term. Further, recent depreciation of the Indian rupee would add to the cost as a majority of TiO2 is imported.

So overall, paint companies might continue to witness margin pressure in near term on account of higher raw material prices.

Political uncertainty in Germany could spark currency volatility near term

Angela Merkel’s Christian Democratic Union party has emerged the largest party with a 33 percent vote share in general elections. However, with its main coalition partner, Social Democrats (SPD) preferring to sit in opposition after a steep erosion in vote share, Germany is staring at political uncertainty.

The structure of the new alliance will affect the form and pace of Eurozone reforms, according to Germany watchers.

In the short run, the Euro could be choppy, tending towards weakness. Eventually, the currency will be guided by the European Central Bank’s efforts towards normalization of monetary policy. Indian exporters to Eurozone should keep an eye on the unfolding political landscape and the monetary policy meetings later in October.

Merkel stays but political equation changes

The other major development has been the rise of the far-right Populist Party – AfD, which won 13.5 percent voting share (vs. 4.7 percent vote share in 2013). AfD is said to have benefited from the public disenchantment with Merkel’s decision to allow Arab refugees into the country.

Political parties change in voting share and expected seats

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Source: Guardian

 

Coalition options not easy to sail through

The key feasible option for coalition being talked about is the three-party tie up, “Jamaican coalition”, between the CDU/CSU, the FDP party (11 percent) and the Greens (9 percent). They have already worked at the state level (Schleswig-Holstein state) but has not been tried at the federal level. Greens and FDP are considered to be arch rivals and getting them to sit on the same side of the table is expected to be hard work.

Various other options have been speculated upon like the alliance between the SPD, Die Linke and the Greens but this would not fetch 50 percent majority. Any possibility of coalition between CDU and AfD has been negated by both the parties.

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Eurozone reforms at stake

A prospective coalition partner for the Merkel-led alliance, FDP, had earlier asked for phasing of European stability mechanism bailout package and provisions to allow countries to leave the euro zone by changes in treaties. Similar demands and coalition dynamics could possibly jeopardize the progress in Eurozone reforms guided by the Macron-Merkel deal.

ECB through its quantitative easing programme has been able to tide over the debt crises and drive the economic recovery. However, in future, for Eurozone to meet the challenges of another economic crises, it should have an independent structure. And that’s why a strong reform-oriented coalition government is the need of hour.

Eurozone reforms topics under Macron-Merkel deal

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Source: http://www.politico.eu

EUR/USD – Volatility

EUR/USD, which had a decent run, recently backed by improving fundamentals and possibility of a change in ECB’s stance can possibly take a breather now. It’s noteworthy that EUR/USD has rallied by 14 percent year to date and the rupee with respect to the Euro depreciated by 8 percent. While export-oriented companies to Eurozone would have benefitted from this trend, which was unlike the trajectory for USD/INR, coming days could witness currency volatility due to political developments.

Chart: currency movements

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Source: Moneycontrol research

Having said that, in the near term, crucial events to watch out for Eurozone would be related to the formation of government in Germany. At the same time Macron’s attempts for a detailed announcement on Eurozone reforms is another aspect to watch out, wherein it’s practical feasibility would be debated and tested.

However, in the medium-term, currency movements should expectedly align to the monetary policy development. While RBI’s policy meet on October 4 would further deliberate on the concerns around low growth and the recent uptick in inflation, ECB’s (European Central Bank) policy meet on October 26 could bring up a plan for phasing out its QE (quantitative easing) programme, amidst economic recovery. If the latter pans out, as expected, there could be further legs to the Euro appreciation.

Prataap Snacks IPO: Premium offering for a consumption growth story

Indian snacks industry is a secular growth story aided by demographics and changing food habits. There are a limited number of players riding on this theme and Prataap Snacks appears to be in the “right place at the right time” but not quite at the right price.

In recent years, with its above industry average growth rate and its product positioning it has not only gained market share from the existing market leaders. It has also forayed into regions which were earlier outside the ambit of organised snacks market.

The company’s focus on market-share maximizing strategy works well for the topline growth but at the cost of earnings. As the company moves up the value chain, margin profile would improve, but with a time lag. Therefore, given the pricing of the issue, short-term upside is limited. However, long term investors can still benefit from this proxy of consumption growth story in the hinterland.

Background

Prataap Snacks (incorporated in 2002) is one of the top six Indian snack food companies. It offers a wide range of snacks food under its “Yellow Diamond” brand. It has three self-owned manufacturing facilities (1 plant in Indore and 2 plants in Guwahati ) with a combined capacity of 80,500 MTPA. In addition, the company has two facilities on a contract manufacturing basis at Bengaluru and Kolkata.

IPO issue size and usage

Prataap Snacks’ IPO (size: Rs 482 crore) consists of a fresh issue of up to Rs 200 crore and an offer-for-sale of up to 3,005,770 equity shares. At the upper end of the IPO price band (Rs 938-930), offer for sale amounts to Rs 282 crore. Post IPO, stakes of Sequoia Capital (61.8 percent) and founders (31.1 percent) would stand reduced to about 48 percent and 23 percent, respectively.

Fresh issue proceeds

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Source: Prataap snacks

Secular consumption market growth

The Indian snacks market is estimated to be about Rs 550 billion wherein the organised market constitutes about 40 percent of the total. As per estimates of Frost & Sullivan, the organized snacks market has grown at the CAGR of 16.2 percent during (2010-16) and is expected to grow by 15 percent in the next five years.

Indian snacks market segments

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Source: Frost & Sullivan

Prataap Snacks: Among top 6 snacks companies

As per Frost & Sullivan, the company has a market share of about 4 percent in the organised snacks food market (Rs 220 billion). It is the third largest player in the extruded snacks market with about 8 percent market share. DFM Foods is one of the closest competitors in this segment with a market share of 4 percent. Prataap Snacks’ market share in the chips segment is 3 percent and competes with Pepsi co and Balaji wafers.

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Source: Prataap Snacks, F&S

Value proposition

The company had consciously targeted tier 2 cities, semi-urban and rural areas for their products. Such a strategy helped it to capture market share from the unorganised sector in the fragmented market in the hinterland. Further, the company derived value proposition through product innovation and relatively higher grammage. (Rs 5 SKUs offers up to 25 percent more grammage per pack vs competitors).

Robust supply chain & strategic location of manufacturing facilities

Prataap Snacks has a pan-India presence through 205 super stockists and 3400 distributors. While executing its distribution strategy, the company tapped unorganized grocery stores and petty shops for the majority of its SKUs as 75 percent of industry sales happen through these channels. It is noteworthy that petty shops usually stock the smallest SKU product (Rs 5 SKU). Therefore, it comes as no surprise that Rs 5 SKU forms a majority part of their revenue.

Prataap Snacks has three owned manufacturing facilities and two contract manufacturing facilities (~8 percent of FY17 revenue) at geographically advantaged locations from the point of view of logistics benefits, sourcing raw material and catering to key markets.

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Source: Prataap Snacks

Financials: Robust topline growth but earnings moderate

Backed by robust distribution and value positioning, Prataap Snacks witnessed a strong topline growth of 27 percent CAGR during 2013-17. Its fixed asset turnover has improved over the years from 2.74x (FY13) to 4.5x in FY17. However, company’s profitability growth has been relatively inconsistent. EBITDA CAGR for 2013-17 has been 10.4 percent. However, excluding last year, operating profit has shown CAGR growth of 27 percent.

FY17 earnings had been impacted by macro events like demonetization along with higher marketing and brand promotion expenses. To improve profitability, the company has reduced distributors’ margins and increased offerings to higher SKU/premium segments (7 Wonders series).

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Source: Prataap Snacks

Risk factors – low profitability compared to competitors

The company is focusing on a market share maximization strategy which though has worked well for topline growth may not necessarily result in similar earnings growth in near term. Its presence in tier 1 cities and the product share in the premium segments is minimal and would take time to scale up. Volatility of raw materials (69-74 percent of sales) and sourcing strategy is another factor which can lead to variability in earnings.

Valuation: expensive bet on a high growth company

Based on earnings multiple, valuations are rich. Even if we normalise the earnings of the last fiscal year as per margin profile of FY16, P/E comes to be about 53x which is in line with the FMCG sector average.

However, for a company in a steep growth phase relying on increasing market share and establishing its manufacturing and distribution network, a look at P/S multiple would be relevant as well, in our view.

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Source: Moneycontrol Research

Compared to its peers, DFM Foods, in particular, Prataap Snacks’ implied price/sales multiple is at a discount. While at the same time, Prataap Snacks’ cash flow generation (from operations) is at 38 percent CAGR (FY13-17) vs 11 percent for DFM Foods.

Given the well-established manufacturing capacity backed by pan-India presence through its distribution chain, IPO offers participation in the volume-led growth of organised snacks industry. Long-term investors can benefit from this proxy of consumption growth story in the hinterland.

US’ interest rate policy remains on course despite temporary shocks from hurricanes

FOMC (Federal Open Market Committee) in its policy statement, released yesterday, reposed confidence in the improvement of the US economy.  Unperturbed by the recent impact of hurricanes and soft inflation, the Fed guided to both balance sheet unwinding and a rate hike by the end of the year. Fed’s continued stance on the policy rate normalisation is apparently positive for the US dollar, particularly with respect to emerging market currencies.

Signaled further policy rate hike later this year

FOMC mentioned that the labour market remains solid (higher job gains and the unemployment rate staying low), household spending is expanding moderately and the growth in business fixed investment has picked up in recent quarters.

As per the Fed dot plot, median end-2017 projection is 1.375 percent implying one more rate hike of 25 bps expected by the end of current year. Market odds for a December rate hike has increased to 60 percent probability (from 50 percent earlier). For the year 2018, the median target is 2.125 percent, unchanged from the last meeting, implying three rate hikes of 25 bps each.

Chart: Fed policymakers policy rate projections

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Source: Federal reserve, FT

USD rallies, US 10-year yield firms up

The dollar index, which was trading lower (91.67), moved up (92.35 currently) after the Fed statement and press conference. US 10-year yield as well edged up from 2.23 percent to 2.27 percent underlining the monetary policy normalization on course.

Lower long term policy rate

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Source: Federal reserve

From a longer-term perspective, the FOMC expectations are for a lower federal fund rate at 2.75 percent vs. 3 percent in June projection. This can be seen as a reflection on the structural changes in the economy guiding for lower real rate for long term (0.75 percent=2.75 percent-2 percent inflation rate).

Hurricane effect transient

FOMC mentioned that storm-related disruptions and rebuilding will affect economic activity in the near term, but past experience suggests that the storms are unlikely to materially alter the course of the national economy over the medium term. Though it might push inflation temporarily which would also be impacted by the recent rise in oil and oil derivatives prices.

However, Fed’s 12 month inflation projection is expected to remain below 2 percent. In fact FOMC’s median projection for 2018 inflation is tweaked lower to 1.9 percent (vs. 2 percent) indicating that inflation would climb to a long-term rate but with a delay. At the same time the Fed emphasised that near-term risks to the economic outlook appear roughly balanced, but the Committee is monitoring inflation developments closely.

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Source: U.S. Bureau of Economic Analysis

Unwinding of balance sheet

The Federal Reserve, in an unanimous decision, decided to commence normalizing the balance sheet from the next month. This marks the last leg of unwinding of QE programme which had quadrupled the balance sheet to USD 4.5 trillion. The Fed announced that it will begin reducing bond reinvestments, starting by USD 10 billion per month and growing to USD 50 billion. This would continue till the central bank’s overall balance sheet falls to the level of USD 2.5 to USD 3 trillion. Market participants expect the unwinding to be a series of gradual adjustments over the years.

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Source: US Federal Reserve

Overall the Fed meeting re-emphasized that policy normalisation is expected to remain on course. While balance sheet unwinding would start in October, the case for another rate hike in December is also likely. Key economic indicators are strengthening and effects from hurricanes are expected to be transient.

While the backdrop is positive for USD, as a corollary, reversal in recent EM currency appreciation cannot be ruled out in the near future.

Inflation data remains pivotal for the Fed policy framework but is expected to rise only gradually. Nevertheless, for currency watchers it remains a key monitorable.

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