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The Too Big To Fail of 2018

Jan 23, 2018

Tanushree Banerjee, Editor, The 5 Minute Wrapup

"When the music stops, in terms of liquidity, things will be complicated," then-Citigroup CEO Chuck Prince said in 2007. "But as long as the music is playing, you've got to get up and dance. We're still dancing."

Despite the carefree dancing, Citigroup did not fail in 2008. Lehman did.

It is not easy to pinpoint the 'Lehmans' in every bull market.

Indian entities have been enjoying the liquidity-induced music for a while now. But they got the real taste of it only in 2017 when domestic mutual funds joined the party.

With about 50 to 60 billion rupees of SIP money every month, the funds were keen to join the party.

It turns out that like Citibank and Lehman in 2008, India's top financial entities ended up enjoying the liquidity party the most.

Mutual fund managers have increased their funds' exposure to financial stocks by 60% over the past year. And a majority of the country's top 20 financial institutions have seen their market capitalization grow between 20% to 80% during this period.

Market Capitalisation of Top 20 Financial Entities (Rs bn)
BSE Total Marketcap124,849154,33423.6%
HDFC Bank3,6715,05437.7%
ICICI Bank1,6702,27035.9%
Kotak Mahindra Bank1,6102,01925.4%
Axis Bank1,1951,51426.7%
Indusind Bank8391,00920.3%
Bajaj Finance65098150.9%
HDFC Standard Life Insurance-971 
Bajaj Finserv65279121.3%
SBI Life-709 
ICICI Prudential-616 
Indiabulls Housing Finance42255531.5%
Punjab National Bank31942733.9%
ICICI Lombard-376 
Gruh Finance14525273.8%
Canara Bank18221618.7%
Motilal Oswal Financial Services10820589.8%
Federal Bank15420331.8%
Weightage in total market cap13.2%15.9% 
Source: Ace Equity
*Marketcap as on 17th Jan 2018

Of course, there are some fundamental differences in the two situations.

Unlike the US' subprime bubble, the asset quality bubble in India is restricted to just a few public and private sector banks and NBFCs. Plus, the earnings of these entities are nowhere near their peaks.

Therefore, in all likelihood, most banks and financial entities in India will not need a Citi-like bailout when the liquidity party stops.

But not recognising the risk that is building up in these so-called safe stocks can be a big mistake.

The liquidity tide cannot continue forever.

The tide is bound to go out. And most funds may then want to exit the party in a hurry.

Getting rid of their heaviest baggage (financial stocks) could help the funds squeeze themselves out. Even if that means selling the stocks of some strong financial entities at throwaway prices.

Howard Marks of Oaktree Capital once said...

  • Germs cause illness, but germs themselves are not illness. We might say illness is what results when germs take hold. Homes in California may or may not have construction flaws that would make them vulnerable to collapse during earthquakes. We only find out when earthquakes occur.

So, even without the need for bailout, the stocks of most financial entities in India are bound to feel the tremors of the market earthquake.

Even if mutual funds do not care to control this risk, you should. To learn more about my safe-stock philosophy, read about my StockSelect service.

Chronicling the Crypto World

If you're new to the world of cryptos, the last few weeks must have been unnerving to say the least. And even if you are a veteran, you surely must have felt the pinch.

If you haven't seen the news, the cryptocurrency market lost over US $300 billion in just one week. That's almost 40% of the total crypto market capitalization wiped out.

So, what's happening?

Like most crashes in the crypto world, there's not one clear cause. But there is a long list a lot of contenders - such as the expiry of bitcoin futures, and tightening regulation in China and South Korea - any one of which would have caused a dip.

When combined together they caused a crash.

Let's take a closer look at the regulation issue.

Some two weeks ago, the crypto world was spooked over news that South Korea is preparing to ban trading in virtual currencies like bitcoin. The country's government and the President's office later refuted this.

What's come out of that story in the last couple of days is that South Korean officials were insider trading on their own news.

Basically, these officials knew they could cause a market crash by putting out statements that they might ban trading. So, they loaded up on cryptos, sold them and immediately put out a statement about banning crypto trading.

Did they then buy the dip? It's likely, but we won't know until the investigation pans out.

There's a lot happening in the world of cryptos. Prasheel Vartak and his guru Tama Churchouse, who have been researching cryptos for years, will keep you on the top of the crypto world's comings and goings. Join them here.

The Indian Pharmaceutical Market on a Slow Wicket

Even as pharma companies reel under the regulatory crackdown in the largest export market in the US, there has been no succour from the domestic markets. The growth in the Indian pharmaceutical market almost halved to 5.5% in 2017. Only 3,932 brands were launched in 2017. This is the lowest since 2013.

The leading therapy segments in terms of brand launches were dermatology, anti-infectives, cardiology, and gastroenterology. Anti-diabetics have also been growing in double-digits for the past five years. However, with the government bringing a number of essential drugs under price control, prescription drugs are witnessing sluggish growth. Therefore, pharma companies are now focusing on the over-the-counter (OTC) medicines.

As per the Nicholas Hall 2017 report, the OTC market is expected to grow at a compounded annual growth rate of 9% and reach US$ 6.5 billion by 2026. So, medication such as dermatology, vitamins, and pain & analgesics have gained centre stage, where most brand launches are taking place.

Domestic Pharma Market in a slow lane

Recently, Lupin forayed into the OTC segment after it re-launched Softovac, its more than three-decades-old brand. Torrent Pharma has acquired Unichem Lab's domestic business which has popular OTC brands such as Unienzyme. The consumer products arm of Piramal Enterprises acquired four OTC brands from Pfizer last year; and recently, it acquired a gastro-intestinal brand, Digeplex, from Shreya Lifesciences.

Thus, while pricing controls keep the operating environment tough in the domestic market, pharma companies with strong brands in the OTC category are better placed to ride the slowdown.

Fund Raising Frenzy Continues

As equity markets scale new highs, India Inc has been frantically rushing to raise funds in the secondary markets through Qualified Institutional Placements (QIPs) and Initial Public Offerings (IPOs). The mouth-watering valuations mean that companies can raise more funds with less equity dilution.

If reports are to be believed, forty companies have announced plans in the last three months to raise funds through the QIP route. The total capital of Rs 400-500 billion is more than 50% of the funds raised in 2017. Apart from this, IPOs valued at RS 130 billion are waiting in the wings for regulatory approval whereas eight companies have filed draft prospectus with the SEBI to raise capital to the tune of Rs 100 billion. Funds amounting to Rs 641 billion and Rs 520 billion have been raised through IPOs and QIPs in FY18 so far.

Banks taking haircuts on bad loans and infrastructure companies gearing up future growth are expected to be in the forefront of capital raising. Some companies are also raising funds to bid for stressed assets that might be up for sale, considering that many debt-ridden companies have been referred to the National Company Law Tribunal for debt resolution. Also, companies wanting to achieve the minimum public shareholding requirement of 25% are taking the QIP route.

While the IPOs offer retail investors with an entry into new businesses, it is worth noting that many of them are simply being used as an exit route for existing private equity investors. Therefore, fundamentals and valuations need to be more critically evaluated for IPOs to be value accretive for shareholders in the long run.

What the Markets Looked Like Today

Indian equity markets opened the day on a strong note. At the time of writing, BSE Sensex was trading higher by 187 points and NSE Nifty was higher by 49 points. Both the mid cap and small cap indices are trading up by 0.7% and 0.5%, respectively. Stocks from the metal and oil & gas are among the gainers.

Tanushree Banerjee
Tanushree Banerjee (Research Analyst)
Editor, The 5 Minute WrapUp

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Investment Mantra of the Day

"Most people get interested in stocks when everyone else is. The time to get interested is when no one else is. You can't buy what is popular and do well." - Warren Buffett

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