the PURSUIT of HAPPYNESS

The end of 2023 is reminiscent of the closing scene of the legendary Will Smith movie 'The pursuit of Happyness'.  One line from the scene sums up what most market participants are feeling - 'This part of my life, this little part is called happiness'. Here is a link to the closing scene - https://www.youtube.com/watch?v=56fngopihOo. This movie is a must watch & although it is about the life of a stock broker yet it has nothing to do with stock markets. 

It is ironical that FY23 & CY23 have ended on a completely different note. Not many could have predicted such a drastic turn of events especially in the micro/small/mid cap space. A little bit of context is required here before we start calling this rise a 'bubble'. Indian economy was deeply stressed through 2013-2020 as NPAs in the financial system had bankrupted 70% of India's lenders. This led to only a select group of businesses scaling & thus performing on the bourses. Once banking was stabilized government spending was directed at activities other than recapitalization of banks & one could see the economy recover faster. This spending towards the real economy helped businesses in infrastructure, manufacturing, power, real estate, railways etc revive & grow. These businesses were priced for extinction & now are getting priced for perpetuity and thus the massive rally. Despite this rally Nifty trades at ~22x on trailing basis which is close to long term averages. 

Macro Context

• GDP growth came in at 7.6% beating estimates by more than 1%.
• India's inflation is at 4.87% moving downwards MOM
• GST collections have growth by ~12% YTD
• Nifty delivered a beat with Q2FY24 PAT growing 28%
• Election mandate is indicating continuity
• Globally inflation is peaking & Fed indicates rate cut in FY 2024
• FII flows have turned positive this month
• Balance sheets look stronger as fund raise has happened via the equity route with IPOs, warrants, prefs & QIPs being the flavor of the season. 

Micro Context

For our portfolio the topline growth for Q2 was ~15% & bottomline grew by ~8%. While this might seem disturbing but ex of one offs the profit growth was 17%. Our portfolios are up 51% on an absolute basis YTD & this indicates the mispricing that exists in some pockets. For most of these names the mispricing continues or numbers are yet to reflect the investments made by these businesses.

A classic case is that of MCX where option volumes have been growing at a rapid pace however elevated software charges due to vendor migration has concealed the entire profitability. While the market punished MCX for near term issues, we chose to bet on the long term potential of a monopoly business. MCX was practically non functional on the 2nd & 3rd day of migration with the exchange discouraging the members to place orders yet NSE/BSE together did not do business of over 100 crores in value in commodities options/futures together. On 13th Dec MCX crossed a turnover of 2 Lakh crores in 1 day. 

Another case is of HPCL - a stock we are still adding to our portfolios. Most managers ignore PSUs & a PSU in the oil space is simply untouchable. However the fact remains that HPCL is one of India’s largest refiners & has great distribution reach. This business has been plagued by government interference as crude prices soared due to Russia-Ukraine war. This interference took place after almost a decade & the stock was penalized. It is one of the few PSUs which have not participated in the rally or been re rated due to this perception of 'government interference'. Meanwhile the company has almost doubled refining capacity to 40 MMTPA & this expansion is either in parent company/ wholly owned subsidiaries or entities where HPCL has a 74% stake thus will be reflected in consolidated numbers. Further a 2.4 MTPA Petchem complex, a 5 MMTPA regasification LNG terminal are also ready to be commissioned. This incremental capex is in excess of 100,000 crores & the company trades at a market cap of ~50,000 crores. This expansion will de risk the marketing business & will have ROEs in excess of 25% given the complexity.  Now with crude receding & marketing margins normalizing we expect earnings to remain consistent. The stock is available at abysmal valuations which warrants us to overlook the PSU tag & associated risks. Over the last few days it has also priced in some price cuts in diesel/ petrol which is inevitable. 

Market View

Risk reward seems in favor of large caps vis a vis small caps. FII flows turning positive & rate cuts in US will benefit large caps & banking in particular. Our portfolios will reflect this but having said that small cap universe is very large & plenty of opportunities still exist thus we remain fully invested.