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Tripti Kedia April 1, 2020
Seated in the iconic BSE building, 81-year-old K.R. Choksey says he has never seen a fall like this in his 59 years as an investor. "Not even during the tech bubble or 9/11. This beats even the 2008 global financial crisis. What makes it different is that finance and health (crises) have come at the same time," says the founder of KRChoksey Investment Managers. The coronavirus pandemic coupled with an economic slowdown could have a devastating impact all over the world, and India is no exception. Most stock markets are seeing steep falls and investors are looking to minimise the red on their books.
In India, the BSE Sensex has bungee-jumped 35.7 per cent, hitting lower circuit a number of times from the beginning of January to three weeks into March. Its market cap fell from a high of Rs 77.7 lakh crore on January 17 to about Rs 50 lakh crore on March 23. Though it recovered marginally to Rs 56.78 lakh crore on March 27, setbacks may occur every now and then.
In 2008, during the subprime crisis, it took the Nifty a full calendar year to drop by 50 per cent. In 2020, it took just 11 weeks for the index to crash 40 per cent. The 21-day nation-wide lockdown will have an impact on GDP growth and weaken investor sentiment further. According to a Barclays research statement - which factors in four weeks of complete shutdown, followed by another eight weeks of partial shutdowns until the end of May - its new forecast for CY2020 GDP growth in India is 2.5 per cent from 4.5 per cent earlier, and 3.5 per cent for FY21 from 5.2 per cent earlier.
The uncertainty will take a toll. Dipen Sheth, Head- Equity and Strategic Marketing, HDFC Securities, says, "Year 2008 was a result of defaulters, which plagued the financial system. But real businesses were still running. Covid-19 spread is global and is having an impact on real economy and real businesses." But investors are a practical bunch and are already looking for silver linings. Chennai-based Shyam Sekhar, founder of ithought Advisory, says he is looking at 2020 as a year of investments and almost nil returns.
What the Markets Are Pricing In
Today, markets are pricing in the adverse impact on India Inc's balance sheets for the next few quarters. Even blue chip stocks have been brutalised. On March 12, as many as 1,242 stocks were trading at 52-week lows. BSE market cap has eroded 35 per cent since January 17 this year. More than two-fifth of Nifty stocks are down by over 40 per cent from their two-year highs.
In any case, for the last two years, just a few heavy weights were holding the fort. The advance-decline ratio reflects deep seated anxiety over earnings downgrades and weak fundamentals. "Earnings are expected to decelerate across sectors with the first two quarters being very bleak. There is still no visibility of the real spread, impact and cure of the virus. We all have to recalibrate our expectations," says Sekhar.
S&P has slashed its 2020 growth projection for India from 5.7 per cent to 5.2 per cent, as it foresees a recession both in the US and the Eurozone. The forecast for China's growth is down from 4.8 per cent to 2.9 per cent. Amidst this unprecedented situation, a 10 per cent cut in Nifty earnings estimates in FY21 by Motilal Oswal Securities in its 4QFY20 strategy report looks like a positive.
According to Sheth of HDFC Securities, earnings of companies will come down because there will be operating deleverage as business volumes shrink. "One will also see drastically lower bottom lines as pricing power and input costs will be readjusted and there will be margin cracks," he says.
The question that investors are asking is: should one turn a buyer in the D-street sale or steer away from it? For their part, analysts and fund houses have tried to distinguish between the immediate and the long-term impact of this disaster on various sectors.
A Close Look
The Indian markets are facing a two-pronged attack. One is the global black swan event of the corona virus and the extent of damage, and the other is the country's own weak banking and financial sector, marked by deteriorating balance sheets. Yes Bank and Punjab and Maharashtra Co-operative Bank are recent incidents and the DHFL and the resultant NBFC liquidity crisis continues. According to Jigar Shah, CEO, Maybank Kim Eng Securities, banks will have to deal with many a nasty surprise on their NPAs due to retail as well as corporate defaults. "It will be a tough year for banks in terms of capital adequacy and deposits. The problem is being extended to private banks. Things need to improve and one needs to win confidence," says Shah.
Aviation, hospitality and tourism are already being hit hard as passenger traffic has plummeted. All this at a time when many airline companies have to cope with not just high fixed costs but also generous helpings of debt. To cope with the situation, salary cuts are being considered. That means investors will stay away from these stocks till some semblance of a robust business model emerges.
Soumya Kanti Ghosh, Chief Economic Advisor, State Bank of India, says, "On an aggregate basis, it is estimated that the impact of a 5 per cent inoperability shock on GDP could be 90 basis points from transport, tourism and hotel sectors, that could be spread over FY20 and FY21, with a larger impact in FY21." This inoperability shock might inhibit many of India's key sectors such as retail, for both Q4FY20 and Q1FY21.
The manufacturing sector, which accounts for about 25 per cent of GDP, will have to brace itself for a deep cut. According to Motilal Oswal's strategy report, a sharp fall in commodity prices will push global cyclicals towards an earnings downgrade. Sheth says, "I am worried about the lower pricing power and erosion of gross margins in the commodity sector. Upstream companies like ONGC, metal and mining will be hurt."
With Brent Crude being down 54 per cent from January levels, ONGC will take a hit on its price realisations, which in turn will impact profits. In early-March, the stock price had hit a 16-year low.
It is ironic that the benefits of lower oil prices for some downstream companies are being offset by poor demand. However, every dollar drop in oil prices benefits India by $1.4 billion. Therefore, if oil prices persist at the level of $35 a barrel, then India will benefit by $46 billion, according to Kotak Securities.
But metals and mining could take a beating, says Shah of Maybank Kim Eng Securities. "Their plants will operate at lower utilisation for at least two quarters with both lower global prices and lower demand. Companies like Hindalco, Vedanta and Tata Steel have a lot of debt on their balance sheet, which will only add to the pressure." The BSE metal index has fallen 48 per cent since January till March 23. A manufacturing and import halt in the world's second largest economy has affected the entire supply chain, reducing demand, especially when China's own inventories are high.
Auto to Switch Gears
Auto companies in India have been seeing poor sales for many quarters now. And those with exposure to China and Europe will fare worse. Car retail sales in China slid 85 per cent in February alone. Tata Motors stock price tumbled 62 per cent (January 1-March 23), much more than the auto index itself (-43 per cent) as Europe accounts for almost 40 per cent of Jaguar Land Rover revenues.
However, analysts are seeing the glass half full for the auto sector. Even though industry specific challenges, policies and consumer sentiment plague the sector, much of the negative perception is already built into the stock prices. Except for Maruti, many stocks are close to their FY09 price levels. "Besides, prices of metal, polymer and rubber are down 6-10 per cent in the last two months and this will cushion the impact on earnings. Passenger and commercial vehicles may see some pressure due to high prices, but two-wheelers and tractors are on a steady sale path on the back of a good crop season," says Shah. This perhaps also explains why mutual funds have parked Rs2,500 crore in February 2020 in the auto sector alone, which contributes around 7.5 per cent to India's GDP.
Mutual funds were net buyers in March too - buying shares worth Rs 23,047 crore in a single month (till March 23). There is distinct similarity between the current crisis and the 2008 subprime crisis, specially in terms of price earnings (P/E) multiples of BSE Sensex. On both occasions, the peak P/E of Sensex was around 29 (around 28.57 in 2008 peak and 29.18 in December 2019) from where it went into a free fall. The 2008 crisis still appears bigger because the fall was more - to P/E level of 10.63 - while the lowest P/E during the current crash so far has been registered as 15.67 on March 23. This time, however, domestic institutional investors (DIIs), have held on .
While DIIs have been buyers, foreign institutional investors (FIIs) and foreign portfolio investors (FPIs) have fled from the Indian equity playground. They were net sellers - selling stocks worth Rs 58,408 crore in March (till March 27). But this is not only in India. FIIs sold equities worth around $85 billion in March across all emerging markets. The money for now has made its way back to the US treasury as bonds.
Currencies have also seen a sharp fall. The pound has hit its lowest point since 1985. The Indian rupee has slid past the 76 per dollar mark for the first time. Export-oriented businesses such as IT and pharma could benefit from this but import-oriented sectors like petroleum, electronics, metals and minerals might take a beating.
The dollar index has been advancing mostly due to liquidity concerns amid volatility arising from the pandemic. Stimulus packages have been announced by many countries but the traditional crisis response of central banks dropping interest rates is effectively inoperative. Interest rates are already very low in the US, and negative in Europe and Japan.
Back home, the RBI has taken some measures to inject liquidity into the system. It has reduced the cash reserve ratio by 100 basis points (bps) to 3 per cent; cut repo rate by 75 bps to 4.4 per cent (lowest ever) and reverse repo rate by 90 bps to 4 per cent. This will allow banks to lend more. The central bank has also allowed a delay in interest payment and increased moratorium on loans by three months. This should help take the pressure off banks and cut the borrowing cost for individuals and companies.
Analysts say radical steps are needed to cease the multi-layered impact. "Without strong economic stimulus, even DIIs may lose patience. So far, we haven't seen redemptions, but that depends on how Covid-19 is contained and how regulators manage the economy," says Shah.
While retail as a whole may suffer, there are pockets that are likely to see higher consumption. Abhijeet Kundu, VP-Research, Antique Broking, and a long-time tracker of the sector, says, "Grocery retailers are expected to do reasonably well as their sales have spiked due to stocking up of groceries. We have factored in a one-month impact in 4QFY20 and two months' impact in FY21 for all apparel retailers. Sales impact across apparel retail companies is expected to be 2-9 per cent in FY20 and 16-34 per cent in FY21."
Consumption continues to be low and a V-shaped recovery is not in sight. However, the FMCG sector might just be in for some good news after a bumpy FY20. Rural demand, which makes for 40 per cent of sales, could take off due to an uptick in agricultural output. The rabi cultivation season has been good and there is a surge in demand for agri-chemicals. Kundu, however, anticipates no particular increase in urban demand.
The retail and FMCG space will continue to reward investors even though domestic demand in urban areas may slow down temporarily. Sekhar of ithought says, "While large companies may show more resilience, medium and small companies will crack faster causing an unimaginable domino effect on manufacturing, services and consumption patterns."
Up For Sale
Meanwhile, investors must sift through their portfolios, diversify and then look at parking their money in select large caps. Many blue chip companies are currently available at throwaway prices. Sekhar says some stocks were untouchable due to their high valuations but "are trading at a discount of 40 per cent-plus which makes them a good buy." Investors must choose with care, conviction and a long-term view.
The coming weeks and months will be full of uncertainty but the silver lining is to consider the year as full of investment opportunities and not handsome returns.
The writer is a Mumbai-based freelance journalist