April 2008

Markets

After a seeing a 3 month period of weakness, from January till March, markets rebounded well in April. Equity markets were over sold to a large extent and some extent of pull back was expected. This may continue for some time, but the larger problems due to which markets fell continues to exist. Current reversal in the markets may be temporary, and one may see another bout of correction later this year. Interestingly, the pull back in the market was led by stocks in Information Technology. Engineering and construction companies, surprisingly were weak due to some slow down in revenue growth. Several companies that have seen their revenues jump very sharply over the past 3-4 years may find it difficult to maintain growth momentum.

Companies 

Several companies in the portfolio continued to come out with favorable results. The larger IT companies are expecting revenue growth of about 20% and don’t seem to be that badly affected by a slowing US economy. Company management’s believe that despite a slowing market, outsourcing as a proportion of the overall market will increase in a recessionary environment.

CRISIL came out with good results during the quarter. The RBI has made it mandatory to rate all bank loans over Rs 40 Cr and this opens up a market opportunity that is over 10 times the size of the current market. The rating business is also a great business with ‘near’ monopolistic pricing power, low requirement to reinvest capital in the business and a general level of power that one has over its customers.

We have been increasing the investment in Gruh Finance, a 62% subsidiary of HDFC. The company primarily lends in semi-urban and rural areas with lower loan sizes of about Rs 3 lacs. The company has a unique lending model with pricing based on risk levels. It currently has about 80 offices primarily in Maharashtra and Gujarat, the its business model can be replicated in the rest of the country. It has been growing in excess of 30% and the increase in interest rates over the past 2 years does not seem to have affected in non-performing loans.

Had also added to Glaxosmithkline Consumer, the makers of Boost and Horlicks. With health consciousness picking up, the company is witnessing strong demand. More importantly, the stock was trading at less than 12x earnings, which is among the lows that the company has seen in the past.

March 2008

Markets

The negative trend, that began in January 08, continued during the current month. Markets inIndiaand across the world continued to come under the pressure of the restructuring in the global financial system. At the worst point, markets were down 15% for the month, but some recovery towards the end of the month helped the markets close about 10% negative.

Environment

Equity markets in India was hit due to continuing negative sentiment across the world arising from the weakness in the bond markets. It is important to note that the problem that started with weakness in the sub-prime market has shifted to the highly rated AAA bonds. Mis-pricing of AAA securities do not normally last very long and some correction in the immediate problem. On the other hand, the global financial system seems to be at a turning point and would need to reinvest several structures of financial and the period of reinvention may take a few years.

Several people have been asking how some problem in US can affect equity markets in India. Equity markets, to a large extent, are priced based on future expectation and the confidence that one has in the future growth and earnings power of companies. A slowdown in the global mortgage market and methods of financing will have an impact on Indian property prices and to that extent property companies are affected. Similarly, a US slow down can affect the prospects of the Indian IT companies, etc. Major events in the financial systems do affect the confidence in the future, leading to some re-pricing in equity markets.

After the correction witnessed over the past 2 months, we are starting to see good values in the mid-cap space and some of the quality larger caps have started to give some opportunity to build out core positions.

February 2008

Markets

Markets were flat during the month and it is going through a period of consolidation after sharp melt down in the month of January 08. Energy and banking stocks were weak during the month, whereas the defensives like consumers, IT did well during the month. The mid and small cap stocks continued to be weak during the month. With foreigners pull out funds, the Rupee weakened slightly against the USD, leading to some positive outlook for the IT sector. Continued concerns over the US market is expected to weaken sentiment for equity markets.

Budget

As the country moves into a potential election year, the budget was expected to have a strong tinge of populism. The Finance Minister had several things in the budget for the common man (Rs 60,000 cr of farm loan waiver, increase in the tax slab would reduce for someone earnings Rs 500,000 annually the tax burden reduced from Rs 99,000 to Rs 55,000, reduction in excise duty, etc), but withheld any major benefits to large corporate and the richer sections (no change in corporate tax rates, increase in Short Term capital gains tax from 10% to 15%). The budget is increasingly having less new impact as much of the liberalization moves have been done with over the past decade. Now, the key issues are from a implementation perspective rather than the policy perspective.

Companies

With the correction in the market, we are starting to see sensible prices in companies that are good longer term bets. HDFC Bank has seen some correction and started to give prices points where we could increase the holding. The bank is expected to growth in excess of 30% annually for the next several years and run by a management team that constantly reduces risks to such growth. The bank announced the acquisition of Centurion Bank of Punjab during the month, at prices that seems to be about 30% higher than what would consider a good price on a stand alone basis. On the other hand, with the RBI controlling the branch network roll out, the acquisition allowed HDFC Bank to expand its branch network by 70% for diluting its equity holding by about 20%. The move will pay off well if HDFC Bank manages to improve the productivity standards of Centurion’s branches.

January 2008

Markets

Equity markets inIndiaand across the world witnessed one of the worst months in recent times falling over 16%. The extent of correction during the month was even more severe, but recovered some of the losses towards the end of the month. Maximum fall was witnessed in some of the highly speculative stocks, where valuations were stretched. A fair number of stocks fell over 50% during the month.

Environment

At the heart of current problems being faced by global markets is a threat of recession in US. The US economy is 15 times the size of the Indian economy and growth concerns in US will have impact on the Indian economy. With the US economy facing a serious credit crisis and slow down in its housing market, one runs the risk of slow down in Foreign investments in India. We have already seen about $ 3 billion taken out of Indian markets in recent times. The risk that we run in India is an asset price correction, rather than the risk of economic slowdown. As long as one takes a cautious approach to the price that one is willing to pay for securities, the portfolio should do well.

There does not seem to be any major risk of Indian economy slowing down. So far corporate growth numbers continues to be strong, especially the infrastructure related space. One of the most important factors in India is that the country has been able to sustain a reasonably high growth trajectory despite interest rates having gone up 4% over the past 18 months. We believe the economy has substantial cushion to energize the system through interest rate cuts, as and when there is an economic slow down.

Companies

In the context of a global financial market correction, we believe the right approach to investing should be focused on sustainable and recession proof growth stocks. Prices are quite attractive in pockets, after the correction over the past month. Some of the sustainable growth stocks like Crisil, Gruh, HDFC bank, etc held up quite well, but we saw some severe correction among stocks that had run up quite sharply in Dec 07. It looks like the correction over the past month was over done and one should see the market revert back to more realistic levels over the coming few weeks.