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This Sector Will Beat the Demonetisation Blues

Dec 13, 2016

In this issue:
» First of a New Series on Demonetisation Hit Sectors that Will Come Out on Top
» Inflation Could Fall More!
» The Government's Grand Solar Plan Runs into Trouble
» ...and more!
00:00
Kunal Thanvi, Research analyst

In the short run, the market is a voting machine but in the long run, it is a weighing machine. - Benjamin Graham

In times of economic uncertainty, it's easy to forget this quote from the father of value investing. But that would be a mistake.

Ben Graham knew that with markets the more things change, the more they stay the same. He invented the metaphors of the 'voting machine' and 'weighing machine' to drive home this point.

It's simple to understand. In the short term, fear and greed drive the markets. But not in the long term. Only business fundamentals do.

This brings me to demonetisation.

There's no doubt that it has created great uncertainty. We see the negatives around us every day. But the major positives are expected only in the future. Higher productivity...less corruption...a cashless society...a shift in employment from the informal to the formal sector...the widening of the tax base - none of this will happen any time soon, if at all.

Of course, clarity will emerge when more data is released. But what should investors do till then?

Should you sell all your stocks and wait it out? Should you reshuffle your holdings? If so, what should you sell and what should you buy?

A confusing situation indeed.

But we're here to help. Of course, we can't name any stocks here. However, once a week, I'll let long-term investors know what they can expect from various sectors. I'll focus on sectors with many fundamentally strong stocks that are struggling right now.

Let's start with the auto sector today.

Mercedes Benz started selling vehicles in India in 1994. Since then, the luxury car market has grown leaps and bounds and many luxury car brands are in India today. The market has never faced a year declining sales...until now.

Most vehicles in India are financed. Nevertheless, demonetisation has made its impact felt.

But it's not all due to demonetisation. The ban on 2000cc-plus diesel vehicles in Delhi and NCR also had an impact. And now things are so bad that luxury carmakers are offering discounts up to 20%.

And it's not just luxury cars, or even cars in general. The entire sector - four wheelers, two wheelers, commercial vehicles, component firms, the replacement market - they are all under pressure.

I visited a dealer of a popular two-wheeler brand near my home. The salesperson was thrilled just to have someone walk in.

Footfalls have reduced drastically at auto dealerships. This is understandable. Customers have other priorities right now. And so insecurity has gripped the industry. Dealers are desperate to clear inventories. The manager of one auto component firm refused to say when he believed things might improve.

The initial numbers don't look very good. Two-wheeler dealer offtake fell 6% YoY in November. Four-wheeler dealer offtake increased marginally. Auto firms don't provide monthly retail sales numbers but dealers have already taken a hit of 30-40% in new bookings. Manufacturers will feel this effect with a lag of about a month or so.

Typically, in the month after the festive season, automakers suspend production for a few days to carry out factory maintenance. But this time around, the shutdowns will be longer, a few weeks perhaps.

So is all this enough to abandon auto stocks?

No.

Even if sales take a big blow this year, the auto growth story won't break down. Individuals and businesses will buy cars, two-wheelers, and trucks irrespective of demonetisation. A one-year hit to profitability won't change the long-term earnings power of fundamentally strong auto firms.

If anything, the recent correction in auto stocks is bringing valuations down to reasonable levels. The only thing a long-term investor has to do is wait for the market to finish 'voting'. Buying good auto stocks at the right price will likely result in healthy returns a few years later when the market begins 'weighing' them.

Hidden Treasure subscribers can look forward to our latest recommendation later this week. It's an auto ancillary stock. But is it a buy? Find out soon.

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03:15 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.

However, it may help to lower consumer Inflation. The Consumer price index (CPI) is expected to be out today. It would be the first inflation indicator that would be out after demonetisation.

For October, it was at a 14-month low of 4.2%. Now, it's expected to factor in the impact of demonetisation. Hence, it could be well below RBI's year-end target of 5%. It could come in below 4%.

CPI May Hit a 15-Month Low


Demonetisation alone is not helping the low inflation numbers. The expected fall in the inflation will be on account of three key reasons. First, the favorable base effect. Second, the harvest hitting the market. And last, the impact of the demonetisation which is mainly hitting the prices of the perishable commodities like fruits and vegetables.

The RBI in its recent monetary policy review, indicated there could be a temporary reduction in inflation of 10-15 basis points for the third quarter of FY17. However, it also indicated inflation could rise in January and February. Low inflation numbers can pave the way for the RBI to cut rates further.

04:10

The government has set an ambitious target of 100 GW solar power generation capacity by 2022. It has planned 34 solar parks across 21 states. Out of this, projects aggregating 20 GW have already been allocated.

The government has even auctioned projects in these parks. But there are execution issues leading to delays in construction. Like demonetisation, the ambitious solar plan looks good on paper but fails on execution.

According to a financial daily, project developers are facing issues like delays in land acquisitions, lack of access roads, lack of clean green lands, lack of a clear demarcation of land areas in these parks etc. The inability to complete the land acquisition formalities in time has created a situation where project developers have won the bids but there is no infrastructure to start the construction!

The government is inviting tenders even before it completes land acquisition. The delay in this land acquisition coupled with the poor infrastructure makes a clear case of poor execution on the part of government.

04:45

After the flat start to the day, the Indian stock markets were trading in the green at the time of writing. The BSE-Sensex was trading higher by about 150 points (up 0.6%), while the NSE Nifty was trading higher by 36 points (up 0.4%). Most sectoral indices were trading higher with auto stocks leading the gainers.

04:55 Today's Investing Mantra

"Investing is more intelligent when it is most businesslike" - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Kunal Thanvi (Research Analyst).

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4 Responses to "This Sector Will Beat the Demonetisation Blues"

Dhir Bhateja

Dec 13, 2016

Common sense tells us auto industry should do well but wait Tier 1 cities bursting at their seams little growth may be possible in Tier 2 nd 3 cities I believe auto ancillaries should out perform

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Dhir Bhateja

Dec 13, 2016

Common sense tells us auto industry should do well but wait Tier 1 cities bursting at their seams little growth may be possible in Tier 2 nd 3 cities I believe auto ancillaries should out perform

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evaman

Dec 13, 2016

and I forgot ...

We are assuming that the whole economy is what this cash (15+Lakh Crore) represents and that is what is fuelling the whole of auto industry?
What portion of the economy is in cash form?

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evaman

Dec 13, 2016

We need to separate two issues out here. One of demonetisation and the other of cash crunch.
The valuation side apart, if the slow down is due to demonetisation, then should one conclude that people do not have legal tender notes to make purchases ?
Given that there is about 12.4L Cr returned to RBI, should we assume people are returning the money back, they want to comply by forgoing 50% of the amount, differing 25% of the amount and with the balance cant make these purchases?

Cash crunch has slowed down or squeezed one form of payment, but hasnt curtailed it. So nothing explains these except one or more of the following
1. Both Demonetisation and cash flow have affected jobs and earnings of those who had earlier planned to make these purchases which could either mean a deferred purchase or no purchase.
2. People who had plans to purchase have their funds stuck - they are unable to for some reasons transfer the money to the dealers
3. People have deferred their purchases in view of these developments, not knowing what the impact of these decisions could be - to themselves, to their employer/customer and to the industry.
4. Please add ...

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