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Month: December 2023

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Banking Bulls: Exploring Growth Trajectories in the Financial Sector

Banking and Financial Services isn’t just another theme or sector; it has a rich history spanning thousands of years!

More than 2200 years ago, in India during the Maurya period, a financial instrument similar to a cheque, known as ‘Adesa,’ was employed to instruct the banker to pay money to a third party.

Bank Nifty is currently trading at more than double its COVID level (March 2020).

However, it’s interesting to note that the trailing P/E of Bank Nifty is currently trading 4 multiples below both the COVID level and 46 multiples below the pre-COVID level (current P/E 16.12, COVID level P/E 20, pre-COVID P/E was 63+). This implies that during this period, the Earnings Per Share (EPS) of Bank Nifty has tripled from 925 (March 2020) to 2916.

There is an opportunity present, as the underperformance gap between Nifty 50 and Nifty financial services is at the 2008 level (global financial crises).

Credit & Deposit growth have been strong for banks growing @~15.

Share of Private Banks have been increasing in Banking sector:

Beyond Banks New Opportunities are Emerging in BFSI space:

1. NBFC: Driving credit growth

2. Low Insurance Penetration offers long term growth potential

3. Broking: Large addressable market

4. Asset Management: AUM Has Gone Upward:

Financialization of savings gaining traction:

In conclusion, investing in the banking and financial sector in India presents a compelling opportunity driven by a combination of factors. The robust regulatory framework, ongoing technological advancements, a large untapped market, and the government’s initiatives to boost financial inclusion contribute to a favorable environment for investors. The sector’s resilience during global economic challenges and its potential for sustained growth make it an attractive prospect. Furthermore, India’s thriving economy and increasing middle-class population further underline the long-term potential for returns on investment. By navigating the evolving landscape with strategic foresight, investors can position themselves to capitalize on the myriad opportunities that the Indian banking and financial sector has to offer.

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NSE – A Potential Multibagger Unfolding in the Unlisted Realm

In light of the recent multibagger listing of Tata Technologies, with an impressive gain of 140% (IPO Price: 500, Listing Price: 1200), investors are understandably in search of the next lucrative opportunity in the IPO market. While it is crucial to exercise prudence amid such market euphoria, it is equally important not to overlook potential opportunities.

 

At our firm, we have consistently managed client funds with a conservative approach, yet delivering a healthy alpha over benchmarks. As a testament to our success, our assets under management have increased 3X in the last 2 years.

 

Recently, we identified a compelling opportunity in the unlisted space – NSE (National Stock Exchange). In the following paragraphs, we aim to delve into the fundamentals of this potential investment. It’s important to note that the information provided does not constitute guidelines or recommendations for any specific course of action. It is essential for investors to conduct their due diligence and understand that the information presented here is for informational purposes only.

Key Facts about NSE:

  1. Incorporation: NSE was established in 1992 and received recognition as a stock exchange from SEBI in April 1993, commencing operations in 1994.

  2. Global Ranking: NSE is currently ranked as the third-largest stock exchange globally in terms of the number of equity trades.

  3. Financial Performance: Between FY19 and FY23, NSE exhibited a remarkable revenue growth, outpacing the global average by 3.5 times, and a profit growth of 10.6 times.

  4. Corporate Structure: NSE boasts 16 subsidiaries, reflecting a diversified and robust business model.

  5. Investor Confidence: Noteworthy investments by Morgan Stanley and Citibank in 2007, when the market cap stood at 10,000 crores, have yielded exceptional returns. Today, the market cap has soared to around 1.7 lakh crores, representing a remarkable 17x increase over 16 years, with a commendable 22% IRR excluding dividends.

  6. Market Outlook: According to Prabhudas Liladher, NSE stands among the most prominent unlisted stocks in India.

Healthy Financial Growth:

 

Over the last eight years, NSE has experienced a fivefold increase in revenue and a eleven fold increase in profits with a healthy operating profit margin of 80% (FY23)

A robust and healthy increase in dividend payout serves as an indicator of financial strength.

Why NSE?

 

Recently, the number of unique clients at NSE surpassed the 8 crore mark. According to various reports, this figure is anticipated to double in the next 3-4 years. The increase in clients is evident in the substantial rise in turnover.

Regardless of whether a client realizes profits or not, charges from the government, broker, and exchange are inevitable. The brokerage industry is highly competitive, and the shares of government are not available. Consequently, investing in the exchange remains the primary option.

Shareholding pattern:

 

We were genuinely surprised to see the list of investors in NSE.

Sixty percent of NSE is held by top-notch institutions, offering a reassuring level of comfort. Additionally, some of the most prominent investors maintain significant holdings in NSE:

Valuations:

 

Valuation stands as a paramount factor in the evaluation of any potential investment.

 

Currently, NSE is trading at approximately Rs. 3500 in the unlisted market. Considering the FY23 earnings per share (EPS) of Rs. 148, the P/E ratio is calculated at around 24.

 

Comparison with peers:

 

Bombay Stock Exchange (BSE):

 

In comparison to BSE, NSE surpasses its counterpart by 10X across various dimensions. Presently, BSE trades at a P/E ratio of 46 on the bourses. Applying a similar multiple to NSE suggests a potential trading value of approximately Rs. 7500 in the public market.

 

BSE went public with an IPO at Rs. 806 in 2017. As of the current date, it is trading at Rs. 4600 (Bonus pre-adjusted), marking an approximate sixfold increase in six years. Notably, at the time of its IPO, BSE maintained a comparable P/E ratio of 23. The growth not only reflects an increase in earnings but also a P/E rerating over the years.

We have identified two major opportunities:

  1. SEBI has proposed an extension of trading hours for derivatives until 11 PM. This potential adjustment could lead to increased turnover, consequently resulting in higher revenue for the exchanges.

  2. The NSE stands to derive significant advantages from its association with the Gujarat International Finance Tec-City (Gift City). Positioned as an international financial hub, Gift City offers NSE the prospect of heightened global connectivity and increased trading volumes. The diverse range of financial instruments supported in Gift City provides an avenue for NSE to expand its product portfolio and attract a more varied investor base.

Risks:

 

Every investment inherently carries risks, and in the context of NSE, two key risks have been identified.

 

  1. There is an ongoing colocation case with the Supreme Court. NSE emerged victorious in the Securities Appellate Tribunal (SAT) in February 2023; however, the matter escalated to the Supreme Court, which affirmed SAT’s decision in April 2023. Subsequently, SEBI appealed the decision, leading to a hearing in November 2023. The Supreme Court requested additional information, and the next hearing is scheduled for March 2024.

     

  2. There is a risk associated with the regulatory stance of SEBI regarding significant retail participation in derivatives. SEBI may introduce guidelines restricting such participation, adding an element of uncertainty to the market.

     

    These factors underscore the importance of careful consideration and risk management in investment decisions involving NSE.

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MONTHLY MARKET UPDATE & OUTLOOK- NOV’23

World’s Most Expensive Stock – A Tale of MistakeTranscending into Masterstroke

In the 1989 letter to shareholders, Warren Buffett candidly addressed his mistakes of preceding 25 years, identifying the acquisition of control in Berkshire Hathaway as a pivotal misjudgment. Despite recognizing the challenges in its textile manufacturing business, he was tempted by the seemingly attractive price of $14 in 1965.

 

Buffett coined the term “cigar butt approach” to describe this strategy, wherein one acquires a stock at a low price with the intention of selling it for a modest profit, even if the long-term performance of the business is suboptimal. However, Buffett acknowledged the inherent flaws in this strategy, emphasizing that in challenging businesses, solving one problem often gives rise to another—akin to the perpetual presence of cockroaches in a kitchen. Moreover, any initial advantage gained is swiftly eroded by the business’s low returns.

 

Recognizing the shortcomings of the cigar butt approach, Buffett advocated a shift towards acquiring businesses with excellent return on equity and promising long-term prospects.

 

Early on, he implemented this revised strategy, strategically acquiring various businesses under the Berkshire umbrella. Over the ensuing 88 years, Buffett successfully transformed Berkshire from a loss-making textile company into one of the largest reinsurance and investment entity, boasting substantial stakes in industry giants such as Apple, Coca-Cola, and American Express. Notably, the share price appreciated from $19 to an impressive $566,570.00 (Rs. 4.8 crore)– yielding an annual return of over 20% for nearly 9 decades, solidifying Berkshire Hathaway’s status as one of the most valuable stocks.

 

A profound quote from Buffett encapsulates the essence of his strategic wisdom: “Time is the friend of wonderful business and enemy of mediocre.“

Quote of the month

As I’ve come to discover, investing is about much more than money. So as your wealth grows, I hope you will also come to realize that the money is largely irrelevant. And what you will want to do with the bulk of your wealth is give it back to society.

—Guy Spier, Founder, Aquamarine Fund

From the global leaders:

 

“Why India Inc is better placed among emerging markets”: The Hindu

 

“Most Americans I know with money want to invest in India”: Zerodha CEO Nithin Kamath

 

“Move aside, China. India will drive Asia’s growth in the next few years”: S&P Global

Economic Indicators Overview:

 

The Indian economy exhibits promising signs with elevated levels of Goods and Services Tax (GST) collections, a surge in festive season demand, stable retail inflation, subdued input inflation, expanding core sector outputs, and heightened credit growth.

 

Manufacturing PMI: The Manufacturing Purchasing Managers’ Index (PMI) for November 2023 stood at 56, marking an improvement from the 8-month low of 55.5 recorded in October 2023. This indicates the sector’s sustained expansion for the 29th consecutive month, driven by reduced price pressures and increased demand from clients.

 

Core Sector Production: In October 2023, the index of eight core sector industries, including Natural Gas, Coal, Refinery Products, Crude Oil, Cement, Electricity, Steel, and Fertilizers, experienced a robust growth of 12.1%. This follows an 8.1% jump in September 2023.

 

Services PMI: India’s service sector activity expanded at its lowest pace in November, falling to 56.9 as compared to 58.4 in October.

 

GST Collection: November 2023 saw GST collections amounting to INR 1.68 trillion, indicating a significant YoY increase of 15%. This marked the twenty-first consecutive month of collections surpassing the INR 1.4 trillion mark, following the record collections of INR 1.87 trillion in April 2023. Collections for 6 out of 8 months in this fiscal year crossed INR 1.6 trillion.

 

Inflation: October 2023 witnessed a drop in the Consumer Price Index (CPI) inflation rate to a four-month low, settling at 4.87%, down from 5.02% in August 2023. The deceleration in the CPI rate was attributed to a slowdown in price rises for housing, clothing, and footwear. Meanwhile, food inflation remained elevated and unchanged, registering at 6.61%.

 

Foreign Exchange Reserves: India’s foreign exchange reserves continued to remain high for the straight third week and rose to more than a four-month high of $604.04 billion as of December 1.

Equity Market Overview:

 

  • In November, India’s NIFTY index concluded on a positive note, recording a month-on-month growth of 5.5%.

  • Outperforming the large-cap index, the BSE Mid-cap and Small-cap indices displayed robust performances, registering gains of 9.6% and 9.4%, respectively.

  • Sector-wise, the top performers for the month were Realty, Oil & Gas, Healthcare, and Power indices, posting impressive returns of +18.9%, +12.7%, +11.4%, and +11.0%, respectively. Notably, all 13 of BSE’s sectoral indices closed the month in positive territory.

  • Foreign Institutional Investors (FIIs) displayed a positive trend in equity flows for November, with a net influx of +$1.1 billion, rebounding from the -$2.9 billion recorded in October 2023. Meanwhile, Domestic Institutional Investors (DIIs) continued to be net buyers of Indian equities, contributing +$1.5 billion compared to the -$3.4 billion in the previous month. Year-to-date figures indicate that Foreign Portfolio Investment (FPI) net buying stands at US$14.2 billion, while DIIs have invested US$20.5 billion in stocks.

  • In a remarkable achievement, Mutual Funds’ Systematic Investment Plans (SIPs) reached an unprecedented milestone, reaching Rs. 17,073 crore for the first time.

     

Fixed Income:

 

  • During the early December policy, the Reserve Bank of India (RBI) maintained the status quo on the policy rate and left the monetary stance unchanged, aligning with consensus expectations. While emphasizing the gradual decline in the inflation outlook and a soft core inflation print, the RBI expressed caution regarding the potential impact of recurring food shocks on headline inflation prints. The RBI revised the economic growth projection for FY24 upward to 7% (from the previous estimate of 6.5%) while maintaining the FY24 inflation projections at 5.4%.

  • The 10-year Government Securities (G-sec) yield, which fluctuated between 7.35% and 7.39% in October, opened the month at 7.36% but gradually decreased to the range of 7.24-7.28% during the month. The 10-year G-sec closed the month at 7.28% (compared to 7.35% in Oct 2023 and 7.21% at the end of Sep 2023).

  • In November 2023, core liquidity (comprising system liquidity and Government balances) declined from 3.3 trillion in October 2023 to 2.5 trillion by the end of November, attributed to festive season demand and credit uptake.

Way ahead:

 

  • Market sentiment in the equity space improved as risk aversion decreased, supported by positive news globally and locally. Factors such as the deceleration in US inflationary expectations and declining oil prices, despite production cuts and geopolitical tensions, contributed to the positive sentiment.

  • On the domestic front, activity indicators remained buoyant, and the corporate results season witnessed growth in profitability driven by lower costs. While overall revenue growth remained relatively muted, expectations are for improvement in the coming quarters. Businesses dependent on rural areas experienced ongoing stress. The Reserve Bank of India raised concerns about retail unsecured credit and increased capital requirements for banks and non-banking financial companies (NBFCs).

  • Looking ahead, the sentiment appears positive, supported by election results in a few states, instilling expectations of political continuity in the upcoming general elections. However, valuations remain elevated compared to long-term averages, and geopolitical challenges persist, potentially impacting the growth trajectory.

  • We believe that Large Cap-oriented strategies across Large Cap and Flexi/Multi Cap categories seem well-positioned, while asset allocation products can aid in managing downside risks.

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Healthcare may be the new IT

Nilesh Shah, Managing Director of Kotak Mutual Fund, recently emphasized that the Indian healthcare sector is on the verge of robust long-term growth. This growth is fueled by domestic demand, escalating exports, and the transition from unorganized to organized healthcare services. Changing demographics and lifestyles are anticipated to further drive the demand for healthcare services.

 

Let’s delve into the Indian medical industry and explore its promising prospects.

India is a dominant player in global pharma industry:

  1. 3rd largest in pharma production by volume

  2. 200+ countries served

  3. 60% of global vaccine supply

  4. 20% of the global supply of generics.

  5. 40% of generic supply in the U.S.

  6. 25% of all medicine in the UK

  7. 50% of Africa’s requirement for generics

  8. US FDA: 2nd highest approved sites

Foreign Medical tourists grew 30% CAGR during 2014-19 and are expected to grow 4x from pre-pandemic levels by 2030 (0.7mn to 3mn). Affordable and quality treatment makes India a Favored Destination:

Out of 75,000 Indian trained doctors working in OECD Countries :

  1. ~2/3rds are settled in the United States

  2. 19,000 are in the UK.

 

Further, India has the highest number of medical colleges in the world.

API: backbone of successful pharma growth:

 

Active Pharmaceutical Ingredient (API) serves as the biologically active component of a drug, akin to its raw material. India proudly stands as the world’s 3rd largest API producer, boasting over 500 API manufacturers and commanding an 8% share in the global API industry.

 

Several key factors are expected to drive the growth of API further:

  1. Reduced Dependence on China

  2. PLI Incentives Offered by the Government

  3. Rising Demand for Formulations

  4. Global Contract Manufacturing Opportunities

CDMO (Contract Development and Manufacturing Organization): Outsourcing as an opportunity has a large Total Addressable/Available Market:

  • Drug lifecycle entails a long drawn process of discovery and development stages, followed by commercial manufacturing

  • Above involves high failure probabilities, forcing global Big Pharma to outsource (in part or full) drug lifecycle stages to CDMOs

  • Indian pharma companies are now playing pivotal role in driving global innovation through the CDMO route

Biosimilars is still an untapped long term growth lever for Indian companies:

  • Biologics adoption in global pharma is progressing rapidly as such drugs address unmet needs (e.g., oncology) and are less toxic

  • Half of today’s top selling drugs are biologics

  • Various Indian companies are investing to develop biosimilars, which are generic equivalents of biologic drugs

Rising longevity, rise in chronic diseases and growing elderly population will lead to increased healthcare spend over the long term

 

The world is experiencing an aging demographic shift:

  • In 2021, 1 in 10 people were aged above 65 years.

  • By 2030 (expected), 1 in 6 people will be aged above 65 years.

     

It has been observed that medical expenses increase rapidly with age, with per capita spending rising from $16,977 to $32,903 as a person ages from 60 years to 85 years.

The boom in the Healthcare Sector parallels that of the IT Sector:

  1. The initial wave of the IT boom was propelled by the low cost of software and manpower, akin to the current situation in the healthcare sector where the affordability of medicines and medical solutions is driven by the process patents held by Indian companies.

  2. The growth of the IT industry in the 2000s was fueled by the export of IT products and the establishment of India as an outsourcing hub. This mirrors the present state of the healthcare sector, which is experiencing growth through the export of generic medicines.

  3. Scalability played a crucial role in the expansion of the IT sector, and similarly, there is significant potential for scalability in healthcare products, particularly in specialized care and hospital services.

In conclusion, it is reasonable to assert that the Indian healthcare system in the immediate and medium term is undergoing a significant transformation from its historical norms. Fundamentally, it will embrace greater technological innovation, extending healthcare services directly to people in their homes or clinics, resulting in a more personalized and affordable experience. For consumers, this shift promises enhanced access to healthcare and improved service quality. In summary, the Indian healthcare system is poised for a promising and bright future.

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Navigating the Manufacturing Boom in India

The Indian manufacturing sector is currently experiencing substantial transformations driven by a convergence of factors including evolving skill requirements, government policies, technological advancements, and global trends. Its significance in shaping a country’s GDP and generating employment opportunities cannot be overstated.

To adapt to the evolving landscape, numerous multinational companies are strategically implementing the ‘plus one’ strategy. This approach involves diversifying production and supply chain operations, thereby reducing dependence on manufacturing solely in one country or geography.

 

India’s manufacturing sector is poised for significant growth, attributed to a combination of factors such as a large and youthful population, a rapid digital revolution, increasing urbanization, and a favorable business environment.

India’s manufacturing sector stands out as a promising powerhouse for several compelling reasons:

  1. Government Initiatives: The Indian government has introduced the Production Linked Incentive (PLI) scheme, a strategic move to attract investments in critical manufacturing segments such as automotive, semiconductor, mobile phones, green energy, and more. This initiative serves as a catalyst for industry growth.

     

  2. Global Investments: Several global industry leaders have committed substantial investment plans in India, establishing new manufacturing sites. This trend not only enhances reliability but also adds resilience to India’s manufacturing ecosystem, making it an attractive destination for multinational corporations.

     

  3. Reform-driven Organizational Growth: Ongoing reforms, including the implementation of the Goods and Services Tax (GST), the establishment of a robust digital payment system, and other systemic changes over the past few years, have contributed to the industry’s enhanced organization. These reforms have streamlined processes and fostered a more efficient business environment.

     

  4. Geopolitical and Economic Trends: India is strategically positioned to capitalize on the current geopolitical and economic trends driving the diversification of Asia’s manufacturing supply chain. With a substantial working-age population and a well-established digital infrastructure, India emerges as a singular market offering a scale comparable to that of China in the long term.

     

  5. Competitive Labor Market: Boasting a population of approximately 1.4 billion, India is not only the world’s most populous country but is also undergoing a demographic boom. This demographic dividend contributes to a competitive and dynamic labor market, providing a significant advantage for manufacturers in terms of scale and diversity.

The “China +1” strategy has emerged as a pivotal paradigm shift for global companies that historically made substantial investments in China over the past three decades.  The allure of China’s low labor and manufacturing costs, coupled with its expansive consumer market, resulted in a concentration of business interests in the country.

 

The China+1 strategy gained momentum swiftly, driven by the US-China trade war, escalating political uncertainties in China, and the supply chain disruptions induced by the COVID-19 pandemic. Faced with these challenges, global companies sought to diversify their operations beyond China to mitigate risks and enhance resilience.

 

The “China +1” approach presents a significant opportunity for India. Notably, between 2015 and 2021, China’s share in US imports experienced a decline of 367 basis points, whereas India’s share witnessed a notable increase of 58 basis points. This shift underscores India’s growing prominence as an attractive alternative for global businesses seeking to diversify their supply chains and reduce dependence on a single manufacturing hub.

Aggressive Government support and policy reforms

 

India’s manufacturing landscape is experiencing a robust transformation, driven by proactive government support and policy reforms. The National Manufacturing Policy, with its ambitious goal of elevating manufacturing’s GDP share to 25% by 2025, serves as a guiding force in shaping the sector’s trajectory.

 

At the forefront of this initiative is the ‘Make in India‘ campaign, spanning 25 economic sectors. Complemented by the Production Linked Incentive (PLI) scheme, offering substantial incentives ranging from 4-6% on incremental sales, these programs present a compelling proposition for new business ventures. The strategic alignment of these initiatives underscores the government’s commitment to fostering a conducive environment for industrial growth.

 

The impact of these concerted efforts is vividly evident in the remarkable growth of India’s manufacturing sector, which surged by an impressive 210% in FY22. This surge not only attests to the effectiveness of the government’s policies but also highlights the attractiveness of India as a destination for businesses looking to thrive in a supportive and incentivized manufacturing ecosystem.

Over the last two decades, the manufacturing sector has experienced a significant decline in market share within GDP and stock market indices, losing ground to the service sector. Despite confronting numerous crises, the manufacturing sector has demonstrated improvements in key structural indicators such as return on capital employed (ROCE), working capital investment, and cash flow utilization.

 

Looking ahead, with unforeseen expansion anticipated in manufacturing over the next few years, driven by both domestic consumption and exports, there is a potential for the revival of the manufacturing sector. Over the next 5-10 years, the manufacturing sector has the opportunity to reclaim lost market share, both in GDP and equity indices. This resurgence is contingent upon sustained positive trends in structural data and the sector’s ability to capitalize on emerging opportunities in the evolving economic landscape.

Onesta Capital Ventures is a Multi Family Office based out of Gurugram (India). We aim to provide tailored independent wealth management and other family governance solutions to individuals and corporates.

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