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Inflation concerns mean rates stay as is…

As was broadly expected, The Monetary Policy Committee (MPC) on Wednesday left the policy repo rate and reverse repo rate unchanged at 6 percent and 5.75 percent, respectively. Out of six members, five members voted for no rate cut and one member voted for 25 bps rate cut. RBI continued to maintain its view that the 4% target on inflation remains its focus. Retail inflation measured by year-on-year change in the consumer price index (CPI) had recorded a seven-month high in October, and with an indicated range of 4.3% to 4.7% for the next two quarters, along with higher inflationary expectations getting built in through the possibility of higher oil prices and some possible fiscal pressure, this was very much in line with expectations. Surplus liquidity in the system has also continued to decline, reducing chances of rate cuts going forward.

Focus on the real rate of return

With the RBI referring to possible green shoots on growth starting to appear in the economy, it does seem that whilst they will continue to track data closely, strategies that are focussed on interest rates getting reduced are likely to face pressure. However, considering that real rates of return (returns from fixed income investments less inflation) continue to be significantly positive, we continue to believe that investing in fixed income is attractive.

Your Investments

Considering positive real interest rates, and equities continuing to trade at significant premiums to long term price to earnings ratios,  it may be a good idea to continue to have fixed income exposure through a combination of largely accrual, short to medium term, and hold to maturity strategies. For investors willing to continue to look at interest rates heading downwards, dynamic bond funds that have flexibility to move across bond maturities, can be explored for a small portion of the fixed income portfolio.

Your Loans

The RBI’s decision to hold rate cuts could indicate that there is unlikely to be any impact on existing lending rates, especially home and car loans by banks. Whilst the transmission of the rate cuts for bank loans over the last couple of years has only been partial, we believe that interest rates may not head down much more going forward.

Way Forward

Considering that the next policy meeting on Feb 6 and 7 is likely to be post the Union Budget, one will need to track how the government manages its fiscal policy and its focus on growth going forward. Global interest rates headed upwards, will also continue to drive RBI’s decisions on interest rates.

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Sixth bi monthly RBI Monetary Policy FY17

The RBI monetary policy committee ( MPC ) reiterated what it has indicated in its last meeting in December – concerns around core inflation continue to remain with seasonal impacts on currently low inflation on items like vegetables likely to go away over a period of time, a strong global recovery that could create inflationary risks though higher prices of commodities including oil, volatility in global currencies on the back of rate hikes in some developed economies and some pass through of the HRA component of the 7th pay commission implementation.

Whilst none of this was really new, there continues to be a view that what the MPC says and what they will do are different from each other. With two consecutive policies that have reiterated the same thing, we believe that markets will finally believe that the MPC means what they say, and their actions will be consistent with the same.

It is therefore critical to continue to remember that managing inflation in the 4-5% pa range continues to be the number one priority of the RBI , and therefore decisions are likely to be taken keeping this in mind, more than other data points.

Your investments

The RBI also moved its policy stance to ‘ neutral ‘ from ‘accommodative ‘ which possibly means that the interest rate cuts from its side are probably coming to an end. This may mean that investment strategies that were driven around interest rate cuts need to be pared down. However, we need to remember that a neutral policy does not mean that interest rates are going to go up on bonds and fixed income instruments, so there is no need for a complete change in investment strategy on fixed income side. A strong global recovery as indicated in the policy statement ,is actually excellent news for the Indian economy, as a global growth environment has traditionally been positive for Indian companies, and therefore one should expect corporate earnings to get better going forward. The MPC has also indicated that they expect the economy to start showing a recovery going forward, so investments in equities could be enhanced for longer term investors. One also needs to remember that even thought RBI has probably stopped cutting interest rates, banks would possibly continue to cut loan rates as the transmission of the 1.75% rate cuts have only been about 0.85% to 0.9%, meaning that corporate India could continue to see lower loan rates going forward, helping their bottomline.

Your loans

With the banking sector flush with funds, and transmission only partially done, you can expect to see loan rates continue to drop for individual borrowers as well. It is a good time to refinance your loans, especially your home loan, in case you have not done so already. Be choosy about the loan provider that you use, as different variants of loans available could mean that you need to pick what works best for you.

April 6 is the next date to watch for the MPC meeting – expect some volatility in bond and currency markets till then, as they react to this shift to a neutral stance as well as other global events.

 

 

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ICICI Prudential Life Insurance Company Limited is the largest private sector life insurer in India by total premium in fiscal 2016 and assets under management at March 31, 2016. It’s a joint venture between ICICI Bank Limited, India’s largest private sector bank in terms of total assets and Prudential Corporation Holdings Limited, a part of the Prudential Group, an international financial services group. It offers a range of Life insurance, health insurance and pension products and services.

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Source: Kotak Securities

Quick facts

  1. They were the largest private sector life insurer in India by total premium in fiscal 2016 and assets under management at March 31, 2016.
  2. In fiscal 2016, their market share on a retail weighted received premium basis was 11.3% compared to a market share of 9.7% of its nearest competitor among all private and public insurance companies.
  3. As of March 31, 2016 they had 1, 21,016 individual agents and as of July 12, 2016 their bank partners had over 4,500 branches.
  4. Their expense ratio of 14.6% for fiscal 2016 was one of the lowest among private sector life insurance companies
  5. As of March 31, 2016 their solvency ratio was 320% compared to IRDA prescribed level of 150%

Strengths

  1. Consistent and robust fund performance

Funds representing 92.9% of their market linked assets performed better than their respective benchmarks since inception.

  1. Quality service experience

In fiscal 2016 their grievance ratio was 153 per 10,000 new policies issued compared to private sector average of 345 per 10,000 new policies issued.

In fiscal 2016 their claim settlement ratio for retail death claims was 96.2% compared to private sector average of 89.4%.

  1. Their expense ratio of 14.6% for fiscal 2016 was one of the lowest among private sector life insurance companies

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  1. Diversified multi-channel distribution network

They have a growing bancassurance network. ICICI Bank and Standard chartered             Bank currently exclusively distribute their life insurance products. As of March 31, 2016 they had 1, 21,016 individual agents and as of July 12, 2016 their bank partners had over 4,500 branches. According to CRISIL Research, Life Insurance Industry Report, July 2016, they have one of the largest channels among private sector life insurance companies in India in terms of premium as on 31 March, 2016.

  1. Digitisation and transformation of sales, customer onboarding and internal processes:

They have created a device agnostic technology platform that provides their customers, employees and distributors with seamless experience from sales to claim settlement. In fiscal 2016, 92.3% of their new business applications were initiated on their digital platform either by distributors or customers. This has also helped them improve employee productivity. Their retail weighted premium received per employee grew at a CAGR of 29.1% from fiscal 2014 to fiscal 2016. They have an architecture which can integrate their systems with partners quickly which facilitates faster issuance of policies.

  1. Robust risk management and control processes

Risk is an integral part of an insurance business. They have risk management and control processes with a detailed cost benefit analysis for risk mitigation and a strong focus on credit quality of their portfolios.

  1. Experienced Senior Management Team

Their CEO, Mr. Sandeep Bakhshi has been with their company for over 5 years. He joined ICICI group in 1986 in project financing group of ICICI ltd. He has over 32 years of experience in the banking, financial services and insurance sector. 28 of top 36 members of their management team have been with ICICI group for over 10 years. Senior managerial persons in the actuary, investment, underwriting and claims department have average functional experience of 16 years.

  1. It has fairly good persistency ratio compared to peers

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Data Source: kotak Institutional Equities

Risk factors

  1. Adverse effect on equity market in India could have an impact on their business as it will have an impact on their market linked products.
  2. Change in market interest rates could have impact on their investments and business profitability.
  3. Their inability to attract or retain distributors, key sales employees could have a material impact on their finances.
  4. Any shift in consumer attitude towards financial savings could have an impact on their business.
  5. Catastrophic events, including natural disasters could increase their liabilities for claims and have an impact on their finances.
  6. Most of their new business premiums come from few products. Any constraints in selling these products due to regulatory changes could impact their business.

Valuations

The embedded value (EV) represents present value of future profits from assets after adjusting for risk. The price to embedded value multiple is approx. 3.4 times FY16 EV. Compared to multiple of HDFC and max life which is 4.2 times FY16 EV, valuations are attractive.

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Data Source: Mint, 14 September 2016

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Our opinion: Subscribe, but only if you are doing so for the long term

Whilst it is the first of its kind IPO in its space and has a large distribution network, strong brand franchise, strong solvency ratio, good settlement ratios, an attractive price to embedded value ratio relative to Max/HDFC and an experienced management, the fair value of the stock in our opinion is lower than the current offer price for the IPO. Thus, you should look to subscribe to this issue only with a long term investment horizon, as the offer price currently does not provide significant upside in the short term in our opinion.

 

 

 

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L&T Infotech is a large global IT services and solutions company, NASSCOM (National Association of Software and Services Companies) ranked them the 6th largest India IT Services Company in terms of export revenues in 2014.

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L&T Infotech has come up with an IPO of Rs. 1228 Cr. The details are as under

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Data Source: JM Financial

Purpose of the issue

The purpose is to provide liquidity to the existing shareholders.

Quick facts

  • They offer IT services in diverse industries such as Banking & Financial services, insurance, energy and processes, consumer packaged goods, retail and pharma, media and entertainment, hi-tech and consumer electronics and automotive and aerospace.
  • Their range of services includes application development, maintenance and out sourcing, enterprise solutions, infrastructure management services, testing, digital solutions and platform based solutions.
  • Larsen & Toubro Ltd. was incorporated in 1996. The L&T group provides them with access to professionals with deep industry knowledge and its corporate and business culture

Besides India, they have global presence

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  • Their revenues from continuing operations increased from Rs. 34278million in FY 13 to Rs. 49680 million in FY 15.

Strengths

  • Their business to IT connect model

They are one of the very few IT service providers who are part of such a diversified business conglomerate. The experience and institutional knowledge of the L&T group helps them to capitalise on strategic opportunities at a faster pace.

  • The strong brand support

L&T provides them with a competitive advantage and helps them in attracting talent, clients, capital, benefit of parent’s global network, best corporate governance practices, etc. They can continue to capitalise on the ability to engage with strategic global clients, vendors and partners of the L&T group.

  • Established long term client relationships

Their client base includes world’s largest and well known organisations including 41 out of fortune 500 companies. They have a history of high client retention and derive significant amount o revenue from repeat business.

revenues from continuing operations

They carry out regular surveys which helps them ensure high level of client satisfaction. They provide customised client solutions flexible to their client needs through their “Thought Partnership program “ which is designed such that they work with business leaders from their clients on business specific needs like reducing run costs, realigning IT with business changes and helping tem envision their future technological needs.

 

  • Track record of established process

 

They have expanded their onshore, offshore and near shore presence thus developing their global delivery model. They have a reputation for delivering high quality IT solutions and timely completion of projects. They have a track record of executing a number of large, end to end critical projects in diverse business areas.

Risk Factors

  • Their business will suffer if they fail to innovate, anticipate and develop new services and enhance existing services to keep pace with change in technology.
  • Due to their global presence their revenues and profitability will be impacted by exchange rate fluctuations.
  • They derive a significant portion of their revenue from a limited number of corporate clients and their revenues could decline if they lose a major client.
  • They may be liable to client’s loss caused due to system failure, disclosure of confidential information or data security breaches.

Valuations

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Extracts from P&L

It has experienced earnings growth in all periods except 2013-14.

Earnings per Share

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PE Ratio based on 31 March 2015 EPS

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Comparison with peers

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PRE based on 31 March 2016 EPS

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Data source: JM Financial services, DRHP

Our opinion

You can consider subscribing to this IPO and exiting post listing.It has a reasonable valuation compared to peers at this stage, but it does not have a very differentiated business model.

Data Source: DRHP

Image credit: economydecoded.com

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budget 2016
1. HRA benefits to be enhanced from Rs. 24000 per annum to Rs. 60000 per annum under section 80GG.

2. Pensions get boost with NPS benefits tax free upto 40%.Retirement savings boost begins, MF arbitrage continues though. Move to boost retirement savings,

3. Long term capital gains tax on equities seems like it is untouched.Biggest worry for the markets till this morning moves away

4. Tax on dividends in excess of Rs. 10 lakhs introduced at 10%. Double tax again?

5. TDS rationalization introduced. Details awaited.

6. A recent survey shows job application fraud at 5 year high -digital repository of certificates should help.Big benefits for biz

7. New Health Protection scheme upto 1 lakh & additional topup of Rs. 30000 for senior citizens.Good initiative -implementation key

8. Section87A rebate increase from Rs. 2000 to Rs. 5000 practical solution. Cost of compliance possibly higher than tax revs there

9. EPFO & NPS choice gets more complex for employers & employees,with new subsidies on EPS contribution for 3 yrs for new employees

10. First time home buyers – loans upto Rs 35 lkhs – for value of house Rs 50 lkhs – additional tax deductions announced.

11. NRI without pan to get relief. Customs baggage rules for passengers to be simplified.

12. Surcharge for incomes above Rs. 1 cr enhanced to 15%. Very much on expected lines. Clearly not a onetime levy as earlier promised.

13. Voluntary disclosure of domestic undisclosed income with payment of 45%.Hope the fine print does not dissuade disclosures.

14. Central legislation to deal with illicit schemes duping investors

15. Relief for MSMEs with turnover Rs. 2 cr or less – presumptive income

16. Comprehensive code -for resolution mechanism to deal with bankrupty situations. Banks to benefit.

17. Presumptive tax at 50% for professionals earning upto 50 lakhs seems too high. Not sure this works.

18. Deepening of corporate bond market big boost for corporates & Debt mkts. Steps to build retail participation in long term bonds needed

19. NHAI,etc to raise 15000 crore in 2016 to give impetus to infra -more tax free bonds? Good for retirement portfolios if continued.

20. 100% electrification in villages with a target date in 2018 is a big step. Greater confidence on back of past performance.

21. Rs. 55,000 cr for roads n highways – huge investment in road and infra rs 97,000 cr in the coming yearr, togethr with rail @ Rs 218k cr

22. Continued focus on road building is good long term step. Focus on what has a worked well is good mgmt. Build on what has worked.

23. Doubling of farmers income in 5 years will depend on the real income increase i.e. post inflation inc. Hope inflation is controlled.

24. CSR funds & donations for higher education capital fund creation -is Rs 1000 crores good enough for an initiative of this scale?

25. Digital literacy creates equal access, but self help requires intrinsic motivation & job access. Can enough new jobs be created?

26. Fiscal discipline, tax reforms & financial sector reforms as part of 9 pillars of 2016.

27. Fiscal target to be maintained at 3.5% – good news for bond markets & positive for India rating. Fiscal prudence wins for now.

28. Fiscal target range as a strategy to be reviewed through a committee to factor ext. environment changes. Hope range is narrow.

29. Govt gross borrowings and net borrowing numbers seem lower than expectations – positive for bond markets.

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Indian Equity markets once again touched all time highs by crossing the 28500 level on the BSE SENSEX due to various reasons like structural reforms made by strong government, weak commodity and oil prices, inflation easing further, improvement in macros and continued foreign flows on the back of strong  liquidity conditions overseas

Equities:  The CNX Nifty and CNX Midcap increased by approx. 6% in the last one month. The local market sentiment has remained buoyant through the last few quarters as the market anticipates a strong domestic recovery and lower interest rates in an improving policy environment. Various macro factors like GDP growth, Current Account Deficit (CAD), Fiscal deficit (FD), IIP, WPI and CPI are showing an encouraging trend in FY 2014-15, compared to last year FY 2013.

Featured imageSource:  Citi Research, HDFC MF, Colored rows refer to yearly data; other represent quarterly data

Corporate margins are currently at cyclical lows, and though earnings are still to significantly pick up and may take a few more quarters, better managed companies are starting to show some traction. As corporate margins normalize from depressed levels and as interest rates move lower, current P/Es that look expensive could start to look much more justifiable.

However, it is critical to have a long term horizon for investors buying into equities as always, as there could be volatility in the short term, especially with a consensus positive view on India. A consensus positive view tends to be a good contrarian indicator very often, so having a long term view and holding some cash to buy on corrections could be a good idea.

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While the U.S. continues to normalize its monetary policies, the same does not apply elsewhere. To overcome weakness in Europe, China and Japan, the respective central banks are taking steps towards more monetary easing to stimulate growth in their economies.

Emerging Markets like India and China have adopted a more flexible exchange rate system, increased Foreign Exchange reserves and managed their external debt in an efficient way thus far.

Featured imageSource: MSCI, Credit Suisse, I/B/E/S, FactSet, J.P. Morgan Economics, J.P. Morgan Asset Management “Guide to the Markets – Asia.”

Investors should remain disciplined in maintaining a well-diversified portfolio by investing across domestic and international equities. A global economic recovery should favour equities, especially emerging markets like India and China that are likely to benefit from a global recovery.  Both emerging markets and developed markets should benefit as a result.

Over the long term, the INR should continue to depreciate vs. the USD at nearly the rate of inflation differential between India and US (last 30 years CAGR of INR depreciation vs USD is 5.5 %; inflation differential between India and US is 4.8%). Therefore, we continue to recommend building international exposure in the portfolio for the purpose of diversification and act as a hedge against currency risk.

Fixed Income: While the equity market is on a high, there are good investment opportunities that we foresee in the fixed income market. There are various factors that impact inflation and the table below shows that they are moderating:

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Investors should start looking at bonds and bond funds (a combination of short, medium and long term options would be recommended, depending upon investment objectives and risk appetite) as a means of hedging their future reinvestment risks.

Globally the gap between US &Indian interest rates is currently high, yet, a sharper than expected reversal in US interest rates could lead to volatility / challenges for the Indian fixed income markets as well. Foreign portfolio flows into debt have also been at a high for many months now, as can be seen from the graph below, and thus investors need to be cautious about any reversal in fund flows. Thus maintaining a long term view on fixed income investments (18-36 months) wouldalso be crucial.

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CPI inflation eased to a series-low 5.5% in October 2014 from 6.5% in September 2014 in year-on-year (y-o-y) terms.  This primarily reflected a sharp decline in food inflation to 5.8% in October 2014 from 7.6% in September 2014, even as core inflation was unchanged at 5.9%.

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Source: CSLO, ICRA Research

However, RBI may not cut the rates in the upcoming monetary policy in December unless they are very sure of achieving CPI inflation target of 6% by January’2016. In addition, it may want to reward investors with continued positive real returns of between 1%-1.5% p.a. over and above inflation, which should help monies move from physical assets like real estate and gold to fixed income instruments as well.

Gold: Gold may continue to see downward pressure globally, with weak commodity prices, and less fear amongst global investors. The government has removed gold import restrictions in spite of the fact that gold imports went up significantly in the last festive month to $3.75 billion. Hence, allocating only a small portion of your investments into this asset class continues to be a good strategy in our view.

We came across a very interesting table recently showing the returns on CAGR basis and the risk measured by standard deviation over 1, 3 and 5 years holding periods of the BSE SENSEX, 1 year SBI Fixed deposit (FD) and Gold in INR terms for the last 30 years:

Featured imageSource: Bloomberg, HDFC MF

As you can see from the above data that:

FDs vs Gold: Fixed deposit returns are very close to the Gold returns in the last 30 years; however the volatility or risk in gold is much higher compared to the risk in FD. Hence, Gold is not a superior option compared to FDs to invest in from a risk perspective.

Equities vs Gold:  Long term returns on equities are much higher than returns on gold (appreciation in Sensex was 5x of gold*). Volatility of equity returns is high but to a lesser extent (3x over 3 year holding periods and 2x over 5 year holding periods). Equities are therefore a superior asset class compared to gold for long term investments and for those with tolerance to volatility.

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India equity markets celebrated Diwali in style, with the Nifty regaining the 8,000 mark and the Sensex moving above 27000.

There was plenty of positive news flow from India like the Government announcing a series of policy reforms including diesel deregulation, gas price hikes and e-auction of the cancelled coal blocks. The victory of the BJP in the Assembly elections in Maharashtra and Haryana too buoyed sentiments.

Equity:

Nifty increased by 1.02% whereas CNX Midcap increased by 1.44% during the month.

The Price to Equity ratios continues to show that equity market valuations are above 20 Year average and it is therefore critical to see earnings pick up to justify current valuations . Early signs show that it is starting to happen as you can from the chart below on both PAT and EBITDA margins for Nifty companies:

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Source: Motilal Oswal Research, 2014

In the graph below it is very clear that investment growth has picked up recently in India compared to some of the other emerging markets (like Brazil, Russia and Mexico), but needs to rise further for economic growth to improve structurally.

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Source: Morgan Stanley Research, October 2014

Global economic growth woes continued – the IMF downgraded its economic outlook on the globe due to weaker than expected global activity in the first half of 2014, along with ongoing Middle East tensions, the Ukrainian and Russian standoff, along with the Hong kong political unrest. The new epidemic disease Ebola is also a big concern in U.S, African and European countries. News from Europe also continues to be challenging. The US ended its bond buying program but maintained its stances on keeping interest rates low for a considerable period, in line with market expectations. Whilst it is very tempting to move to a 100% domestic portfolio in this environment, we continue to recommend to have at least 10% of the portfolio invested globally for the purpose of global diversification, as well as act as a hedge against currency risk.

With projections of GDP growth of 5.5 percent in FY 2014–15 and 6.5 percent in the following year, Q2 2014 GDP growth came at 5.7%, above the consensus expectations. We believe that the Indian economy is on the cusp of a growth uptrend and this will contribute to growth in corporate earnings as we have shown in our charts above in this article and hence will justify strong performance of Indian equities, especially with oil and commodity prices coming off. However, it is critical to keep you asset allocation intact.

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Source: MSCI, Credit Suisse, I/B/E/S, FactSet, J.P. Morgan Economics, J.P. Morgan Asset Management “Guide to the Markets – Asia.”

Fixed Income

CPI inflation eased to a series-low 6.5% in September 2014 from  7.8% in August 2014 in year-on-year (y-o-y) terms and Core-CPI inflation (excluding food, beverages & tobacco and fuel & light) declined significantly to a series-low of 5.9% in September 2014 from 6.9% in August 2014 (refer chart below)

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Source: CSO, ICRA Research

Inflation related to fuel & light moderated to 3.5% in September 2014 from 4.2% in August 2014 in y-o-y terms. Softening of prices of various commodities including crude oil and domestic fuel prices would benefit the CPI trajectory in the near term and hence we continue to expect the Reserve Bank of India’s (RBI) January 2015 target of restricting CPI inflation below 8.0% to be achieved.

Nevertheless, the probability of a Repo rate cut in 2014-15 remains low, as the RBI is likely to continue to focus on containing inflationary expectations to improve the likelihood of restricting CPI inflation below the January 2016 target of 6.0%.

The below chart shows the Interest rate differentials between US and India:

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Source: Axis Mutual Fund

There is a fear that higher US rates will draw FII money away from India. This is not borne out by history. During 2004-06 even with rate hikes money continued to flow into India from FIIs. Secondly, back in 2004 at the start of the cycle, US rates were at 1% and Indian rates were at 4.5% implying a 350 bps differential. By the end of the Fed rate hikes, the rates were respectively 5.25% and 6.50% implying a differential of just 125 bps. In contrast currently the US is close to zero (officially the overnight target is 0 to 0.25%), while RBI is at 8%, a differential of nearly 800 bps.

Hence, we recommend having the fixed income portion of the portfolio comprising of both accrual and duration strategies where accrual strategies will lock into current high interest rates and duration strategies will start benefitting once the interest rates start coming off over the next 12-24 months.

Gold:

Demand for Gold has seen a rebound in recent days in India and China. India celebrated Diwali, the biggest gold buying festival  which boosted physical demand for the yellow metal on support of low prices. Meanwhile, a surge in Gold imports pushed up the India’s trade deficit for September to $14.25 billion of which Gold imports accounts for $3.75 billion. This raises questions on whether there can be some quantitative restrictions or higher import duties put on gold , to bring down the demand. Hence, allocating only a smaller portion of your portfolio in Gold continues to be a prudent strategy.

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