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Is it the Time to Buy Aviation Stocks as Fuel Costs Fall?


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The past one month was fantastic for Indian aviation stocks like Indigo and SpiceJet, which rose 9% and 8%, respectively. It was only Jet Airways, that declined during the month.

But Jet Airways has been facing another set of issues altogether.

Jet Airways' woes got much worse last week, with the cash-strapped airline defaulting on its loan repayments to a consortium of Indian banks led by the State Bank of India.

This debt default, the airline's first, marks a serious deterioration in its troubled state of affairs that has seen it delaying salaries and aircraft lease payments.

But that's a topic for another day.

Coming back to surge in share prices of airline stocks last month. What was the reason for this industry-wide jump?

Two words: Oil Prices.

High Crude Prices Ground Aviation Stocks

Fuel is the largest expense for airlines. Fluctuations in fuel prices have the single biggest impact on an airline's bottom line in the short term.

Because the cost of jet fuel corresponds tightly to crude oil prices, movements in the price of crude oil affect how much airlines pay for Aviation Turbine Fuel (ATF).

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So, when oil prices go up, airline stocks feel the pinch. When oil prices drop, airlines can make hay while the sun shines and their share prices usually increase.

Best example is 2014 when oil prices dropped by more than 50%. Aviation stocks were flying high that year.

As you can see in the chart below, lower ATF prices resulted in the industry reporting positive operating profit margins since 2015.

With 2016 reportedly being the best year of profitability in over a decade. The ATF prices stayed at multi year lows of Rs 30-40 per litre.

Falling ATF Prices During 2014 Boosted Airlines' Profit Margins

Of course, the opposite is also true.

When oil prices climb, as they did in the second half of 2017, airline stocks tend to underperform the broader market.

That is exactly what has been happening until now.

The sector got an apt New Year present of lower ATF prices.

According to Indian Oil Corp. Ltd, average ATF prices for domestic airlines, at the four metros, have declined by nearly 20% compared to the average for the December quarter. These are the lowest monthly prices in this fiscal year.

In a relief to India's aviation industry, oil marketing companies slashed jet fuel prices by around 15%.

This is the second consecutive reduction in the prices of ATF after around 10% cut in December.

ATF costs has been the major reason to why airlines posted lackluster earnings in Q2FY19. Indigo's fuel cost rose by a whopping 84% in Q2FY19.

The chart below shows how with an increase in oil prices, the net profits of the companies fell during the September quarter in 2018.

Rising Fuel Costs of the Airline Stocks
Poor Q2 Performance as Fuel Costs Rise

However, important to note here is that, its not only oil prices that drive the shares of airline companies. A case in point is Jet Airways and Air India.

Broader economic indicators can also have a big impact.

On top of that, OPEC and Russia recently announced a production cut, which caused oil prices to rise. However, that bump was short-lived.

So, while it seems that lower fuel prices may be likely to stick around through the year after all, it's important to know that the lower fuel price environment is not necessarily a permanent feature.

There is always the risk that prices will inch higher.

Over the past one year, all the listed airline companies in India have underperformed the benchmark index.

It can of course be argued that the very fact that these stocks have underperformed could now turn them into potential future winners. After all, stocks revert to the mean, don't they?

Of course, they do.

But let's first see what co-head of research at Equitymaster, Rahul Shah has to say about it:

  • "But the principle is applicable to companies that are efficiently run, have strong balance sheets and are only victims of an economic downturn or the downturn in the industry. But when companies have negative networth like both Jet and SpiceJet do and also have balance sheets loaded with debt, it is usually a good idea to stay away from such companies rather than invest in the hope that things will indeed turn around one day.

    If they haven't all these years, there's a very small possibility that they will in the future. And one shouldn't bet too much money on a scenario that with little or no upside and the downside that can go all the way to possible bankruptcy."

So, what can we conclude here?

No doubt the capacity has been growing at a brisk pace, the important question whether lower fuel prices will ensure that load factors remain high.

Load factor measures the capacity utilisation of public transport services like airlines. It is used to assess how efficiently a transport provider fills seats and generates revenue.

So, while the trends on demand and load factors are yet to play out, the positive factor right now is that ATF prices have come back to levels where low-cost airlines can generate decent profits.

Also remember, although air travel is becoming the new normal, investors need to understand the industry dynamics before buying any aviation stock.

Best Regards,
Rini Mehta



This article (Is it the Time to Buy Aviation Stocks as Fuel Costs Fall?) is authored by Equitymaster.

Equitymaster is a leading 'independent' equity research initiative focused on providing well-researched and unbiased opinions on stocks listed on the Bombay Stock Exchange.

Click here to Read full Details Sources @ http://feeds.equitymaster.com/~r/eqtm/~3/x9yuRRq-ZBs/detail.asp

Airtel, Vodafone-Idea or RJio - Who Will Win the Telecom Race?


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The giants that ruled a couple of years back went extinction when a new baby was born in this country.

India's richest man Mukesh Ambani's telecom baby, Reliance Jio, was born in September 2016.

With the launch of Jio, India's telecom story was re-written. India's biggest operators, Bharti Airtel, Vodafone India, and Idea Cellular were caught by surprise, and they were yet to gauge what was in store for them in the coming times.

In a matter of just 12 months, the 12 telecom operators in the country, suddenly shrunk to 4.

Small players vanished from the market. Others who survived, started counting days that are left, unless they do something new. They are forced to revisit their strategies, and in most cases, follow the newcomer.

Market Share: Then & Now

The entry of Reliance Jio resulted in a tariff war, which forced even a large corporate house like the Tata Group to exit the industry (In October 2017, Tata group decided to sell its consumer mobile business segment to Bharti Airtel virtually for free).

Following a year-long consolidation, the current stage where the incumbent players, Bharti Airtel, Idea+Vodafone and BSNL+MTNL (Public sector) are hemorrhaging has possibly reached the last lap.

The last lap is running to the pace of RJio.

With the market share divided among several players in 2016, the top 3 players have captured most of the market.

See the chart below.

In terms of subscriber market share, Vodafone Idea has the highest market share of 38%, followed by Bharti Airtel at 29.8%. Reliance Jio stands third with 18.4% market share.

What About the Financials?

Here again, the incumbents have been badly impacted.

In the June 2016 quarter, before new entrant Reliance Jio Infocomm Ltd started steering the ship, Bharti Airtel's India wireless unit boasted annualized revenue of more than Rs 600 billion.

Notably, revenues and profits have fallen almost every quarter since then.

However, in the September 2018 quarter, revenues are showing the signs of growth. Will these players will now go on the path to recovery?

As our research analyst Taha Merchant believes the situation is unlikely to change soon. Here's an excerpt of what he wrote:

  • "Speaking of difficult businesses, the whole telecom business has been an underwhelming story so far. While the telecom subscriber base has increased from 300 million in 2008 to 1.2 billion in 2017, investors have little to cheer. The BSE Sensex has gone up 3.25 times in nine years, but the BSE Telecom Index has not moved an inch from its levels of 2008.

    Telecom companies are straddled with high debt, intense competition, and lack of pricing power. High spectrum costs and regulatory issues have hampered the sector. While consumers have benefited from low costs and new players fighting for their share, investors have suffered."

Subscriber Base Versus Revenues

Among the three leading players, Vodafone Idea has added over 444 million subscribers as on June 2018.

Interestingly, Reliance Jio, which had 215 million subscribers compared with Vodafone Idea's 444 million as of end-September, made a profit of Rs 6.8 billion in the same period.

The third player, Bharti Airtel lost around 64 million users between June 2017 to June 2018 whereas Reliance Jio added 92 million during the same period.

Reliance Jio Surpasses Bharti Airtel in Terms of AGR

Reliance Jio has surpassed Bharti Airtel to become the second largest telecom operator in terms of adjusted gross revenue (AGR) in the quarter ended June.

In India, AGR has specifically become important for telecom companies since the payment made to the government is based on the AGR.

As per the data released by TRAI, Jio recorded an AGR from access services or revenue derived from licensed services of Rs 71.3 billion for the June quarter, while Airtel's AGR stood at Rs 67.2 billion.

The development highlights strong growth of the new entrant and declining strength of the former market leader. RJio had surpassed Vodafone and Idea Cellular individually in the March quarter but lags them now since the two merged to form Vodafone Idea at the end of August.

Rising Debt...

Meanwhile, as Reliance Jio inched closer to Bharti Airtel in terms of revenue market share, Jio's net liabilities have risen at a fast pace.

Meanwhile, debt-to-equity ratio of the incumbents have also remained high. This simply shows the considerable cash burn at the two firms because of the cut-throat pricing in the industry.

Hence, leverage for the sector seems to remain elevated on relentless competition, which in turn is hurting the profitability. Cash flow generation is constrained because of continued capital spending.

Although the dust in the telecom battleground has settled largely, the sector is at the point wherein no clear market leader emerging on key growth metrics and no distinct industry hierarchy in sight.

In the run-up to 5G, the next stage will mark a qualitative transformation and bring stability to the telecom sector.

But that is still some distance away. In the meantime, incumbents will have to dig in and pour more investment to hold their market share.

Best Regards,
Rini Mehta



This article (Airtel, Vodafone-Idea or RJio - Who Will Win the Telecom Race?) is authored by Equitymaster.

Equitymaster is a leading 'independent' equity research initiative focused on providing well-researched and unbiased opinions on stocks listed on the Bombay Stock Exchange.

Click here to Read full Details Sources @ http://feeds.equitymaster.com/~r/eqtm/~3/2vabczawOlk/detail.asp

Why the Realty Sector's Recovery Has Been Delayed


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What happens when you throw a pebble in a pond? The impact of the stone breaking the equilibrium of the surface of the water causes ripples to spread outwards.

Think of it in this way... stock markets are like the pond and Infrastructure Leasing and Financial Services (IL&FS) represents the pebble.

You may have been hearing about it frequently these days, 'IL&FS crisis is at the heart of the problems in the economy and stock markets.'

I suppose, lot of you are even feeling the pinch of it. But, what exactly happened? How did this IL&FS crisis start? What triggered the crisis in last few months?

What began as a singular event with IL&FS, failing to repay its dues has blown up into a liquidity crisis for the entire non-banking financial companies (NBFC) sector. As an immediate aftermath, NBFC stocks witnessed a free fall.

To put it simply, IL&FS defaulted on a few payments and failed to service its commercial papers (CP) on due date, which means the company started facing a liquidity crunch.

The company piled up too much debt to be paid back in the short-term while revenues from its assets were skewed towards the longer term.

IL&FS has a huge outstanding debt of Rs 910 billion out of which Rs 570 billion is due to Public Sector Banks.

Further, in July this year, IL&FS' subsidiary IL&FS Transport delayed Rs 4.5 billion of repayment to SIDBI. This is when the IL&FS crisis started.

Owing to the several payment defaults, ICRA and CARE started downgrading the company's ratings. As Tanushree Banerjee, co-head of Research at Equitymaster, rightly pointed out in The 5 Minute WrapUp, that rating agencies were late to ring the alarm bells this time as well.

Rising NPAs and Debt - Early Indicators of IL&FS' Liquidity Crisis

Rising NPAs and Debt - Early Indicators of IL&FS' Liquidity Crisis

Here's what Tanushree wrote:

IL&FS was a designated systemically important NBFC which borrowed money from the banks, public at large and other NBFCs. With its problems out in the open, the element of trust stands shaken.

The current NBFC crisis has had a cascading effect on the real estate sector.

Post the banking system's freeze on real estate funding due to rising NPAs, The NBFCs & housing finance companies were a major source of funds for developers.

Now, the NBFCs themselves are struggling and their loan disbursals to the real estate developers have slowed down significantly.

Two years ago, demonetisation caused upheaval in many sectors and the real estate sector also had to bear the brunt.

Coupled with slow pace in home sales, the roll-out of goods and services tax (GST), and the introduction of new real estate regulations (RERA), had severely impacted new launches and expansion plans of several developers.

When it seemed that the pain reduced with these measures being in place and real estate prices getting rationalised, the recent NBFC crisis caused a stir in the residential markets.

Consequently, realty stocks have been hurt the most among sectoral indices, since the correction in the Indian stock market started in late August.

The change of stance on interest rates and liquidity concerns for NBFCs hit the sector, which had just started seeing a recovery.

BSE Realty Index has Fallen 18% Since August

While the BSE Sensex dropped 6% since 1 August 2018, the BSE Realty Index eroded 18% of its value. In fact, all the 10 components of the BSE Realty Index have lost value since then.

Indiabulls Real Estate fell the most, declining 39%. Sunteck Realty, Prestige Estate, and Mahindra Lifespace fell 21%, 30% & 24% respectively during the same period.

All BSE Realty Stocks Under Pressure Since August 2018

In the recent development, the home buyers and realty developers are facing severe cash crisis despite Reserve Bank of India's (RBI) increasing bank credit to NBFCs and HFCs.

The scale of problem is so huge that the even the sanctioned home loans are not being disbursed. The cash crunch has also pushed up home loan interest rates.

So, what can we make of this scenario? What lies ahead?

A source of broad-spectrum disappointment and despair, the NBFC crisis needs to be resolved as soon as possible or the real estate sector's much-anticipated recovery will be postponed further.

Further, the real estate sector is going through a consolidation i.e. weaker people (with bad ethics practise) are going out of business after RERA.

Now with this liquidity crunch, companies with weaker balance sheets will be under pressure and hence will result in further consolidation.

In the long run, companies with strong balance sheets and ethical managements, with long track records, will win and do well with much less competition.

Happy Investing!

Best Regards,
Rini Mehta



This article (Why the Realty Sector's Recovery Has Been Delayed) is authored by Equitymaster.

Equitymaster is a leading 'independent' equity research initiative focused on providing well-researched and unbiased opinions on stocks listed on the Bombay Stock Exchange.

Click here to Read full Details Sources @ http://feeds.equitymaster.com/~r/eqtm/~3/5ErpgOJvwPw/detail.asp

IPO Market Feels the Heat of the Market Crash


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A robust IPO market needs two things: favorable stock market conditions and companies that want to sell shares.

Both are absent in the current market conditions.

The sentiment has deteriorated rapidly in the secondary market in the last couple of weeks.

The BSE Sensex is already off its record high levels, and given the global trade war, sharp drop in the rupee, deterioration of the current account deficit, and the uncertainty of the upcoming state elections and general election, volatility has been on a rise.

It all started with the liquidity fears from mid-September and the consequent downturn in the benchmark indices. This has made market participants extremely cautious, leading to Initial Public Offerings (IPOs) receiving a muted response in the primary market.

We could see in the latest offerings this month. The IPO of Dinesh Engineers was withdrawn after it received muted response on the first day of bidding.

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The IPO of Garden Reach Shipbuilders & Engineers also drew a weak response. The company was forced to extend its IPO by three days and also cut the price band to Rs 114-Rs 118 against the original price band of Rs 115-Rs 118 per share.

Also, if you look at the S&P BSE IPO Index, it has fallen nearly 18% this year as compared to the Sensex, which is flat for the year.

How has IPO Benchmark Performed So Far?

Among the IPOs listed so far, 14 are trading below their issue price. The market crash has taken a toll on their share prices.

Apollo Microsystems, ICICI Securities, and Indostar Capital Finance are down by over 50% since its listing. While, CreditAccess Grameen, Hindustan Aeronautics, and Bharat Dynamics are trading 30% below their listing prices.

IPOs/Public Offering: Performance snapshot

Moreover, those that had enjoyed high listing premiums have now seen huge price erosion. The worst hit includes HDFC Asset Management Company. It is down from Rs 1,970, its all-time high price, to Rs 1,268, after touching a 52-week low of Rs 1,248.

The HDFC AMC public offer was allotted at Rs 1,100 per share and had listed at 58% premium to the issue price.

Similarly, Bandhan Bank which had hit an all-time high of Rs 742, is down to Rs 485, below its listing price of Rs 499. Bandhan Bank had listed at a huge premium of 33% over its issue price of Rs 375.

The chart below indicates the top 5 gainers and 5 losers during the year so far. Fine organics stands as the best performer among all the listed IPOs in 2018. While, Apollo Microsystems leads the pack of losers, falling over 61% since its listing.

Top IPO Overperformers & Underperformers in the Market Crash

The lull in the IPO market would also hinder the government's disinvestment target and upset its fiscal math. The government has set its FY19 disinvestment target at Rs 800 billion. The ongoing volatility in the domestic equity market may force the government to postpone its planned stake sales and of some the IPOs.

While the recent market crash and the macro uncertainty is a big cause of worry for investors, it must be recalled that Indian stocks were driven to unsustainably expensive valuations on the back of a flood of domestic liquidity.

Ankit Shah, editor of Equitymaster Insider, believes the ongoing market crash has brought valuations down to reasonable levels. This may be a good time to scoop up great long-term investing opportunities.

Yes, that's right.

Here's a snippet of what he wrote in The 5 Minute WrapUp recently:

  • "Of course, this doesn't mean that stocks couldn't crash further if things get worse.

    The correction could last longer.

    But looking at the history of equity returns, I can tell you that this would be just a passing correction phase.

    Despite all the volatility and periodic crashes, equities are still one of the most rewarding and safe asset classes over the long run."

Here's the bottom-line: The short-term performance of the secondary market and the second quarter earnings season would largely decide the course for the primary market.

Can the subdued IPO space offer investors an opportunity to acquire shares at reasonable valuations in the remaining part of the year? That will be something to watch out for.

Honestly, it is hard to decide whether to apply for an IPO or ignore it when the masses are thronging to buy them.

How can you decide which IPO is the right one? We have good news.

To help you approach IPOs in the right way, we have prepared a special report on IPO Investing.

To know how to safely profit from the ongoing IPO rush, download this FREE report now and discover... How to Get Rich with IPOs.

Moreover, at Equitymaster, we also release detailed notes on the upcoming IPOs. Keep an eye out for them.

Until next time...

Best Regards,
Rini Mehta



This article (IPO Market Feels the Heat of the Market Crash) is authored by Equitymaster.

Equitymaster is a leading 'independent' equity research initiative focused on providing well-researched and unbiased opinions on stocks listed on the Bombay Stock Exchange.

Click here to Read full Details Sources @ http://feeds.equitymaster.com/~r/eqtm/~3/oqJFQCgKAFU/detail.asp

Aavas Financiers IPO: Should You Bet on This Affordable Housing Finance Company? (Subscriber Feature)


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Aavas Financiers Limited is registered with the National Housing Bank (NHB) as a Housing Finance Company (HFC).... [Read More]

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Garden Reach Shipbuilders and Engineers Ltd: Is This PSU Shipbuilder Worth Betting On? (Subscriber Feature)


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Garden Reach Shipbuilders and Engineers Ltd (GRSE) is a shipbuilding company under the administrative control of the Ministry of Defence (MoD).... [Read More]

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IRCON International IPO: Is This PSU Worth Betting On? (Subscriber Feature)


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IRCON International plans to launch its much-awaited IPO on 17 September. The IPO is priced in the range of Rs 470-475 per share.... [Read More]

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As the Rupee Takes a Record Plunge, These Pharma Stocks Gain the Most


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The Indian rupee, which has been depreciating over the past few months, touched its all-time low of Rs 71.98 against the US dollar today. While this is expected to impact the economy, some solace can be found when one looks at the exporting sectors like pharma.

Most pharma companies generate their revenues through exports. Hence, a depreciating rupee is a positive development for them.

If the rupee continues to trade near its current levels, pharma companies are likely to get a push in their revenues and earnings. This especially bodes well at the times when pharma companies are seeing significant challenges in growing their US revenue due to higher competition.

Pharma Companies' US revenues

Pharma Stocks Back in Vogue?

The rupee's recent weakness has pushed up the BSE healthcare index, which was (26% down) at the bottom of the market for the past three years. However, the index has been the top performer in the past month and is up 11%.

The sector was underperforming amid pricing policy in the US generics market, patent protection, and regulatory overdrive, among other reasons.

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However, in the past three months, the BSE healthcare index has gained as much as 23%. In comparison, BSE Sensex is up about 9% during the same period.

Among the individual stocks, Sun Pharmaceutical Industries, Dr Reddy's Laboratories, Aurobindo Pharma, and Glenmark Pharma outperformed the index by gaining in the range of 14% to 19%, while Divi's Laboratories and Lupin were up 13% and 10%, respectively.

Beating the Benchmark

Meanwhile, Merck, Novartis India, Pfizer, JB Chemicals & Pharmaceuticals, Anuh Pharma, Shilpa Medicare, and Apollo Hospital Enterprises have rallied more than 23% during the month.

In fact, many pharma stocks also hit their 52-week highs recently.

Sun Pharmaceutical Industries, Dr Reddys Laboratories, Glenmark Pharmaceuticals, Torrent Pharmaceuticals, Abbott India, Merck, Sanofi India, and GlaxoSmithKline Pharmaceuticals were among 11 stocks that hit their respective 52-week highs.

Meanwhile, Sun Pharma has been the star performer. The stock hit a fresh 52-week high of Rs 669 this week. In past three months, the stock rallied 36%.

In addition to the rupee depreciation, there is also purely news driven triggers as well. We have seen Sun Pharma's Halol plant getting approval. The Halol plant had been under USFDA scanner since September 2014 and the quality cloud over it was lifted only last month. The resolution of the issue paved the way for Sun Pharma to resume selling to the US market from this facility, which accounts for 35-40% of the revenue for the company.

One plant of Alembic Pharma also received approval.

Further, Dr Reddy's Lab on August 23 had received an Establishment Inspection Report (EIR) from the US health regulator for its Srikakulam facility in Andhra Pradesh. USFDA releases a copy of the EIR to the establishment that was the subject of an FDA or FDA-contracted inspection when the agency determines the inspection to be closed.

This clearly tells us that pharma story is not just about depreciating rupee. The stocks have rallied in the past three weeks on hopes of facility clearances, lower pricing erosion in the future, and benefits of specialty businesses like over-the-counter medicines.

Is This 2013 All Over Again?

This scenario seems to be a repeat of 2013 when there was a sharp depreciation in the rupee due to monetary tapering by the US Federal Reserve. IT and healthcare stocks were the top performers that year.

Depreciating Rupee & Sectoral Performance

Domestic market-focused sectors such as financials, consumer goods, automobiles, energy, consumer durables, metals, capital goods, and realty either ended in the red or grossly underperformed the benchmark index that year.

The BSE healthcare index has been an outperformer in the past few months, but it is still in negative on a year-to-date basis.

No doubt that valuations have corrected both in absolute terms and relative to the frontline indices. The pharma story is still stock specific as there's not much improvement in the macro picture except for the rupee depreciation.

Note that, MNC pharma companies as well as companies like Eris Lifesciences, FDC, etc. have most of their business in the domestic markets and hence they many not benefit from the rupee depreciation.

As far as exporters are concerned, for better results in the long-term, only currency depreciation in isolation cannot do wonders for them.

So, What Lies Ahead for Pharma Stocks?

One thing is certain, people's perceptions of pharma stocks are changing.

Stocks are rallying. Mutual funds are launching healthcare funds.

But, is this enough to merit a positive outlook on the whole sector? Our Research Analyst, Girish Shetty does not think so.

Here's an excerpt of what he wrote in an edition of The 5 Minute WrapUp:

  • "For one, the healthcare index is diverse. Some companies supply to developed countries. Others are focused on the Indian market.

    Even their business models are completely different. In such a situation, taking a bet on the index seems more like a reaction the price rather than the fundamentals.

    But does that matter to the AMC's coming out with these funds? I guess not.

    Gullible investors get excited and fall into these traps. Once reality sinks in, it's too late to react.

    This cycle of chasing momentum plays out almost every time. The fear of missing out (FOMO) is too strong for retail investors.

    Does that mean I would keep away from pharma stocks?

    Certainly not. We had the same view even when everyone was running away from the pharma sector."

In fact, our team at Equitymaster has recently shortlisted one stock for ValuePro.

Pharma stocks also form a good chunk of StockSelect recommendations. Our research team was positive on these stocks when the negativity around the sector was at its peak.

Meanwhile, market participants will keenly observe how the rupee moves going forward.

While a fresh fall may be bad for the sentiment of the overall market, select IT, pharma, and export oriented stocks seems to be taking advantage of it. These macro factors may have a strong bearing on the movement of the stock markets in the short to medium term.

We will keep you posted on these developments.

Warm regards,
Rini Mehta



This article (As the Rupee Takes a Record Plunge, These Pharma Stocks Gain the Most) is authored by Equitymaster.

Equitymaster is a leading 'independent' equity research initiative focused on providing well-researched and unbiased opinions on stocks listed on the Bombay Stock Exchange.

Click here to Read full Details Sources @ http://feeds.equitymaster.com/~r/eqtm/~3/RkJYHljI1Co/detail.asp

CreditAccess Grameen IPO: Should You Apply to this Interesting Microfinance Play? (Subscriber Feature)


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Last couple of years have been transformative for the microfinance industry. The Reserve Bank of India (RBI) granted small finance bank (SFB) licenses.... [Read More]

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How You Can Profit from this Financialization Trend in India...


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What's buzzing in Indian stock markets this week? I'm sure you would have not missed this headline:

  • HDFC Asset Management Company to launch its Rs 28 billion IPO on 25 July.

There are many reasons for the hype around this IPO.

On a macro level, investors across the world are closely tracking the Indian market. That's because it has been one of the most attractive emerging markets lately.

The way Indians invest their money has gone through a very big structural change. And asset management companies (AMCs) are one of the major beneficiaries.

As we seem to be in a low interest rate regime, a lot of money which was lying in bank accounts moving into mutual funds.

What's more, a lot of investment which used to go into physical assets, whether gold or real estate, is moving into financial assets - a lot of it through the SIP (systematic investment plan) route into mutual funds.

Until a few months ago, it was hard to play the Indian financial story. There were no listed Indian AMCs. But now with AMCs coming up with IPOs, new opportunities are set to open up.

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Why AMCs Are Set to Benefit

Mutual funds have a great compounding business. AMCs' growth in their assets is embedded in the underlying investments.

The capital requirement for mutual funds is low and these companies can scale up without pumping in more than the minimum capital prescribed by the regulator.

With buoyant capital markets and the mutual fund industry on a roll, AMCs are eager to hit the market with their initial public offerings (IPOs).

Soon you will be able to invest in the shares of these AMCs. Many are expected to follow HDFC AMC. This opens up an entirely new segment for investors.

The first mover in this race was Anil Ambani promoted Reliance Nippon Life Asset Management Company that came up with a Rs 15.4 billion offering in October last year.

Interestingly, UTI AMC has also announced plans to list this financial year.

The AMCs' plan to go public follows a growing trend where banks and financial services are looking to unlock value in group businesses after the rapid rise in stock markets.

Apart from AMCs, another segment that's grabbing attention is brokerage houses.

And for good reason.

First, with the Nifty crossing the 11,000 mark, investor interest has held up well.

Interest from domestic investors, high net worth individuals, and retail investors towards equities increased due to demonetisation which shifted money towards financial assets and the fall in interest rates which made fixed deposits unattractive.

This is evident from the data...

Spectacular Financial Performance of India's Top 3 Broking Companies

There seems to be value-buying happening in brokering and related stocks. This is due to the stupendous financial performance of the leading companies in this segment.

Net profits of all three major broking companies have zoomed in FY18.

Net profit of Motilal Oswal, Edelweiss Financial Services, and Geojit Financial Services grew 220%, 115% and 95%, respectively over the three years.

Zooming Net Profits

Also, here's a look of how these companies fare on the valuations front.

Key Metrics of Brokerages

CompanyPriceP/E Ratio P/B Ratio Market Cap (Rs million)
Motilal Oswal796.621.34.1115,429
Edelweiss Financial285.624.73.2222,996
Geojit Financial80.024.44.417,904
Source: company reports, Equitymaster database
*Price as on 18 July 2018

Beating the Benchmark

Also, brokerage houses have beaten the benchmark BSE 200 index by a huge margin over the past two years.

Brokerage Stocks Have Beaten the Index

How Mutual Funds and Brokerages Complement Each Other...

The money garnered through IPOs, and inflows into mutual funds are a testimony to heightened investor interest.

And higher interest means more business for brokerages. Fortunes of stock brokers' core business are linked to the fortunes of the stock market. It is natural that the broking industry's business goes up with the market.

Second, in a bullish market, such as the one we are in right now, brokers' profits grow faster than their revenues.

This is because most of their costs are fixed in nature and, therefore, a major part of the new, additional revenue gets converted into net profit.

Additionally, the shift from phone-based trading to online trading is also helping brokers acquire more accounts and earn higher profits.

Mutual Funds - Emerging from the Ashes

Indian households have traditionally favored real estate and gold as means of investments. Growing financial awareness has led to a rise in financial savings of late. However, mutual funds still have a lot of catching up to do among savings in financial assets. What this implies is that the mutual fund industry in India is still in the nascent growth phase, attracting less than 4% of the population's savings. And that the industry's untapped potential is huge.

Poor Mutual Fund Penetration in India

At the same time, the AUM of the mutual fund industry have nearly doubled in the past two years, from Rs 10.8 trillion in 2015 to Rs 19 trillion in May 2017.

Look at the chart below. It shows tepid investor participation in the Indian stock markets until FY14. But starting from the financial year 2014-15 (FY15), there's a paradigm shift in investments by mutual funds.

The Phenomenal Rise of the Retail Indian Investor

The year 2017-18 (FY18) saw another massive leap in net investments by mutual funds. This was, to quite an extent, triggered by the demonetisation drive and then further propelled by the bull rally in the stock markets.

What does all of this indicate?

The mutual fund industry in India has huge scope for growth and development.

Real estate and gold have become less attractive forms of investments post notebandi.

The reduction in bank deposit rates in the past year has led to a shift in investment to mutual funds and the stock markets.

Ankit Shah, the Editor of Equitymaster Insider, has pointed out how domestic investors have made a beeline to invest in Indian equities like never before.

He presents some compelling market data which shows city-wise trend in AUM of mutual funds between 31 March 2015 and 31 Dec 2017.

Here's an excerpt from his study...

  • "Between FY01 and FY15, foreign investors were consistently above the mutual funds, except in the financial year 2008-09 (FY09). That was the only year in the 15-year period when mutual funds were net buyers in the face of an exodus by foreign investors in the aftermath of the global financial crisis.

    But the dominance of foreign investors has been challenged since FY16. The net investments by mutual funds have exceeded foreign investor inflows in two of the last three financial years.

    This is the reason why markets have remained relatively buoyant despite the heavy selling by foreign investors in recent months. Had it not been for the steady domestic investor inflows, the markets would have been in a deep correction."

The Big Question: Will this Trend Continue?

While all of this is well and good, a question in point is whether this positive trend continue? If they do, how will it play out for these financial stocks and upcoming IPOs?

Despite these positives, many of the broking companies have been unable to gain traction. This can be attributed to the low penetration of equities, low ticket sizes, and low frequency of trading among retail investors.

Nevertheless, with buoyant capital markets and the mutual fund industry on a roll, asset management companies and brokerages are eager to unlock value through initial public offerings.

But how should you think about these IPOs? Are valuations worth it? Is the opportunity of a lifetime or the dud of the decade?

These are the questions that will require much more contemplation. But don't worry - our research team is on it.

We at Equitymaster believe a merit-based selection, primarily including valuation, business, and management quality, is the logical way to go about investing in IPOs. If it means going against the herd, so be it. And going by recent past, this strategy has been proven to be successful more often.

To know how to safely profit from the ongoing IPO rush, download this FREE report now and discover How to Get Rich with IPOs.

Also, we will be releasing detailed notes on these upcoming IPOs - keep an eye out for them. You can read our detailed analysis of the upcoming IPOs here.



This article (How You Can Profit from this Financialization Trend in India...) is authored by Equitymaster.

Equitymaster is a leading 'independent' equity research initiative focused on providing well-researched and unbiased opinions on stocks listed on the Bombay Stock Exchange.

Click here to Read full Details Sources @ http://feeds.equitymaster.com/~r/eqtm/~3/KfK-zmp1Rf4/detail.asp

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