June 2019: Economic slowdown blues

Over the last few months, there are increasing signs of stress emanating from the economy. The most visible of these signs was of course the 4th quarter GDP growth which came in at 5.8% which is an 8 quarter low. We thought it would be a good idea to have a look at the quarterly results of Indian corporates (those that are not in the banking and finance sector, because in that sector because of issues with NPAs, there is a problem of relevant comparison) to try and understand the situation in greater detail. For the median company in the Nifty-50 (non-financials) revenue growth rate which had risen to 15.0% in the Jun-18 quarter from 6.7% in Jun-17 quarter, had fallen to 10.4% in the Mar-19 quarter. Net profit growth which was 19.6% in the Jun-18 quarter had slid to 12.8% in the Mar-19 quarter. For the broader BSE-500 companies, the median revenue growth which was at 15.8% in the Sep-18 quarter had slid to 10.4% in the Mar-19 quarter. At the same time, net profit growth which was in the high teens in the Jun-18 quarter had slid to 9.9% and 7.9% in the Dec-18 and Mar-19 quarters respectively. There appears to be a distinct slowdown in revenue and net profits over the last 2 quarters.

Furthermore, the automobile sales data flowing in for April and May does not paint a pretty picture with car sales growth at decade lows. The automobile slowdown is partly driven by new safety regulations whether they are in terms of ABS for 2 wheelers and airbags, seat belt indicators, etc for 4 wheelers. The other reason for the slowdown in automobile sales is that NBFCs have had a tough time raising money ever since ILFS defaulted in Aug-18. NBFCs have been large financiers of automobiles historically and their presence in lending in general has expanded because the PSU banks have been constrained to lend, because of their large NPA problems.

Meanwhile the corporate debt market has been a minefield over the last few months with new disclosures about defaults being announced almost weekly. A large number of these defaults are in the NBFC sector, which has been particularly hard hit over the last few months as liquidity has dried up for the weaker players in the industry. Many of the NBFCs were funding longer term assets through shorter term funding and at this time of stress, this asset liability mismatch has been a source of trouble for many players. The RBI has announced a liquidity coverage provision for NBFCs which it expects to help reduce liquidity mismatches in the future. In the short term though, this could further add to the stress in the sector. On the positive side, we do see promoters of these companies actively selling off assets to repay loans – at a pace and scale we have not seen before in India.

As such the new government has its hands full in terms of economic issues to get a grip of, as it embarks on its second term. The market meanwhile has been showing a schizophrenic pattern whereby there are a large number of stocks trading at all-time highs, and at the same time, a large number of stocks hitting 52 week lows. While the former are typically the high quality businesses which have been bid up by investors, the latter consists of the indebted businesses and the commodity stocks. Given our focus on the high quality space, we are finding fewer opportunities currently than has been the norm over the last few years. The nature of the current market has also provided us with some opportunities to reduce weights in some stocks where valuations are beginning to get expensive.