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Demonetisation Could Be the Best Thing to Happen to These Stocks

Dec 10, 2016

In this issue:
» Industrial output down in October, demonetisation to make the pain worse
» Tata Mistry saga offers lessons in value investing
» Markets in the week gone by
» ...and more!
00:00
Richa Agarwal, Research analyst

We have been writing to you about demonetisation as a failed economic experiment.

A lot of you don't agree with us. We sincerely hope we'll be proven wrong.

Some of you would prefer positive commentary and for us to suggest how to improve the situation.

We can't paint a rosy picture when we don't see one. But today, we will the leave economic issues to the economists, Supreme Court, Mr Modi, and time...and will talk about what we know best.

On 9 November, the small-cap index witnessed a fall of 9%. Within two weeks, more than 150 small-cap stocks corrected by 20%. The turnover in BSE small cap stocks was down more than 40%...proving once again how vulnerable small caps are to macro events and Mr Market's mood.

But is the situation for listed small caps really so bad?

Kunal has shared some insights from his management meets with small-cap companies in the real estate and microfinance sectors as well as the consumer discretionary and auto sectors. He met these companies post demonetisation, and the slowdown in business activity is evident. The short-term pain is real, but as he said:

  • Pessimism aids the discovery of true prices. And this creates more opportunity for us to recommend fresh buys to our subscribers.

Markets hate uncertainty. They are voting machines in the short term. In the past month, small caps have corrected twice as much as their large cap peers.

In a recent Reuters poll, expectations for the BSE-Sensex and NSE index were downgraded. The small-cap index was not a part of the poll. But I'm sure the pessimism would have been even more severe.

As far as the Hidden Treasure team is concerned, we believe demonetisation has unlocked a great opportunity for resilient businesses and great managers in the small cap space.

As I wrote in the recent Research Digest:

  • In our meetings with managements, one of the common challenges these companies tell us about is competition from the unorganised segment. The latter operate locally on a low scale and rely mainly on cash sales.

    With all the changes taking place around us, it is the informal segment and unlisted small businesses that will be worst hit. The cost of doing business for companies in the unorganised segment is likely to go up.

    And demonetisation is just the beginning.

    As accounting norms are likely to become clearer and stricter for all, tax evasion will be difficult. Meanwhile, India is expected to take further steps in the direction of a cashless economy.

    Further, with GST close on the heels, the story of India, for listed small companies, will become better at the cost of unorganised segment.

Mind you, the informal sector runs mostly on cash and accounts for 48% of India's total output and 80% of employment. As such, the threat to GDP is very real.

Yet, small caps could end up being the biggest beneficiary of this crisis. Not just because of the market share that strong small-cap companies will sweep away from unorganised players. But also because market pessimism could bring valuations of some of the best small-cap companies into the buy zone.

We are keeping a close watch on the businesses that have the strength to weather this crisis and emerge stronger over next two-three years. We believe demonetisation could lead to the biggest buying opportunities in select small caps this year and in the times to come.

Meantime, we still love Junior Bluechips. These are small caps with five crucial blue-chip-like properties. They're three of our highest-conviction stock pics, and we believe these stocks will do well in the long term, irrespective of demonetisation's success or failure.


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02:45 Chart of the day

The demonetisation has disrupted everything- the service sector, manufacturing sector and the farm economy. Even though one would argue it is too early to judge, but a basic analysis suggests painful times ahead.

The best way to analyze and understand any macro situation is to follow the headline numbers for the economy.

Yesterday, Central Statistics Office (CSO) released data on industrial output for the month of October 2016.

The industrial production output for the month declined by 1.9% YoY. This was up 9.9% YoY in the same month last year. After a decline for consecutive two months, it had grown 0.7% YoY for the month of September.

Factory Output Deteriorates, More Pain Ahead


The disappointing numbers were due to decline in manufacturing sector (down 2.4% YoY), mining (down 1.1% YoY) and capital goods sector (down 25.9% YoY).

Mind you, these disappointing numbers are pre-demonetisation.

Now, with the overall sentiments being low across all the sectors, the business activity in India is expected to slow down for next few months. The major contributors to the industrial output like capital goods and manufacturing are expected to face major hiccups. With these numbers bleeding, we expect to see an extended adverse impact on the India's job market as well.

Yesterday, my colleague Tanushree wrote interesting follow up on the destruction of jobs due to demonetisation:

  • And as per estimates, demonetisation will render another 400,000 jobless in a few months. Hindustan Times arrived at this number based on estimates by top headhunting companies in India. Ecommerce, real estate, and infrastructure are expected to shave the most jobs. But mind you, this number is just from the organised sector. It does not include the lakhs of jobs already being lost in the unorganised textile, gems, and jewellery sectors.

    The government will likely be busy making currencies available and offering digital payment sops for months. Schemes like National Skill Development, which were supposed to create millions of jobs, are now on the backburner.

    So the pain of demonetisation will not be felt on consumption growth until the 30th of December 2016. Consumption demand is bound to stay paralysed for much longer. It is not only the cash crush and the suppressed demand that will weigh heavily on consumption. The loss of jobs and underemployment will also hurt.
03:50

Amidst the din of demonetisation, the battle for investor trust at the Tata group has got overshadowed. The group that was once literally synonymous to investor trust will literally face a litmus test of sorts. Six listed Tata companies will have to pick between Ratan Tata and Cyrus Mistry. Also at stake is the ability of Tata Power and Tata Motors to use the Tata brand for raising funds. Cyrus Mistry, the ousted executive, has resisted efforts to remove him as chairman of key group companies. The shareholder vote will not just decide the fate of Ratan and Mistry. It may also change investor perception of the group for good. The important lesson for investors here is to not take the management quality and trust worthiness of a company for granted. More importantly, irrespective of the pedigree, every business must be evaluated on its own merit and bought with enough margin of safety. That's precisely why some stocks of this group make it to our bluechip best buy list and some might never make it.

04:20

Barring China (down 0.3%), major global indices closed on a positive note. The US equity markets closed at a record high on Friday as the broad indices witnessed its best winning streak since June 2014. The European shares had their best week since the beginning of the year.

The European Central Bank surprised investors by announcing that it would trim asset buys from April next year to 60 billion euros per month. Currently it buys 80 billion euros worth of bonds every month. But at the same time it has also extended its bond-purchase program by nine months to December 2017. The ECB action was mix of tightening and loosening measures.

The broad benchmark indices across the Asian countries closed with robust weekly gains. Asian stock markets perceived policy easing by ECB positive. China's stock market announced positive economic data on Friday. While the Shanghai stock markets surged on this news, it closed marginally lower for the week.

The global optimism kindled rally in the Indian indices too. Indian benchmark indices completed their biggest weekly gain since September and closed higher by 2%. The ECB's move of extending stimulus is expected to bring in more FIIs inflows. During the week gone by, the Reserve Bank of India (RBI) unexpectedly kept its repo rate unchanged at 6.25%. The central bank also lowered GDP growth rate forecast for current fiscal to 7.1% and admitted to short-term disruption in economic activities due to demonetisation. The RBI's decision to stay pat on interest rates came as a disappointment for market participants.

04:40
Performance During the Week Ended 9th December, 2016

04:55 Investment mantra of the day

"Be Fearful When Others Are Greedy and Greedy When Others Are Fearful" - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Richa Agarwal (Research Analyst).

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5 Responses to "Demonetisation Could Be the Best Thing to Happen to These Stocks"

R. Thirumurthy

Dec 12, 2016

"We can't paint a rosy picture when we don't see one"
You don't get it.
And you're hurting because in your hurry to pick roses you've let the thorns poke you a bit hard.
Whoever said there's a bed of roses out there without any thorns at all?
Don't you get the 'feelings' of people?
Honest people out there, and they are quite a few, are clutching at straws so they don't feel they will be played for suckers till the cows come home while the scoundrels and scallawags keep strutting around in their obscene venality and corruption.
Remember, please, your team is not merely a stock advisor. You didn't start out that way. I know because I am your subscriber/ reader for over a dozen years.
You guys had idealism and vision going for you before age, exposure and, neck-deep 'factualism', if I may coin a neologism, must have got you.
Back to the board, guys.
Create. Something. New.

Like (1)

kvk

Dec 11, 2016

I agree with Richa here :-) It is good idea to leave politics and economics to people competent in them ( There are just too many of them probably out there to do any good !). And from stocks that i am buying based on recommendations, i think i am doing okay, you are doing good job in recommending that ! Hopefully you will continue to be focused on that.

Like (1)

Naresh Karmali

Dec 10, 2016

Whatever action government takes is always criticized and painted negatively by the media.This has always projected India's Bad image globally. Our PM is working day and night to bring back the lost glory. I don't expect any praises for HIM from any media whose only aim is increasing its TRP. But this TRP makes our future generation Pessimistic about India. And this is the very cause of our BRAIN DRAIN. Every one is talking about cash shortage. No Reporter or any Bank staff ask any person withdrawing more than Rs. 20000/- the reason thereof. As per I-T Act. any payment above Rs.20,000/- needs to be paid by A?C Payee Cheque. If anybody asks for bill businessmen tell- extra tax for bill. Even if this tax is paid by customer there is no guarantee that it will be paid by businessmen to the government. I need not write more how Honest Citizens lived for the last seven decades, just because they were helpless. Now that PM is there, Poor, Middle Class and Honest Citizens should strongly stand behind PM and sacrifice our lives for WELL BEING of our FUTURE GENERATION and STOP OUR BRAIN DRAIN.

Like (3)

DDB

Dec 10, 2016

All major global economies have been facing slowdown, and our economy cannot remain isolated.Slowdown has been there for quite some time now and domestic demand has been lagging,Yet , the media (both print and visual) , market analysts, economists have been shying away from speaking about it and instead selling fantasies about how the GST roll out, Seventh Pay Commission arrears in the hands of people , good monsoon , interest rate cuts would propel GDP growth. All seem to be playing to the gallery and selling fantasies.The stock market movement prior to demonetisation is a vivid example.Now that the inevitable is staring, Demonetisation has come handy for this motley group to take refuge.Affordability is key to propel demand and some sectors in the economy has been seeing valuations not commensurate with the products/services offered."Value for Money "is what the customers expect with legal sources of income.The real estate prices reached dizzy heights far beyond the reach of middle income groups and hence it was bound to collapse.It is no rocket science.The unorganised sector as rightly pointed out is where cash transactions takes place .It may also be noted that it is this unorganised sector where maximum illegal wealth is generated and which exploits the resources of the states to the hilt at the cost of the tax payers.Demonetisation will reduce if not put an end to this and those rendered jobless and with required skill sets would move towards the organised sector. There would be displacements .Time for reckoning the Real Value of Money has arrived.

Like (1)

Uday Pasricha

Dec 10, 2016


Rahul quoted that Pessimism aids the discovery of true prices. And this creates more opportunity. As an anecdotal researcher we have noted more than 30% of white goods, appliances, even two wheeler sales being fed by the cash economy. A deeper look reveals that even a capital investment in JCB type excavators are bought by the cash players so a fair % will fall. However the word pessimism needs to be replaced with honest and real pricing because land values and consumer goods, gold and luxury goods were fuelled by the cash economy. Thia by natural extension would mean that inequality can only increase. In the developed world 400 billion dollars of drug cash supports unbelievable commerce and as soon as the hidden cost of healthcare and crime control must equal that. If illegal drugs were to stop there would be a huge recession in luxury goods. So would falling markets minus drugs be acceotable to the west. India may be the first that has been forced to take this bitter medicine and hopefully this tough decision pays off despite the guaranteed recession which will now follow.

Like (2)
  
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