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Multipie Weekly: July 3, 2021

In current edition of our weekly newsletter we assess half-yearly market performance, explain why Value Investing is not really dead, summarize the Financial Stability Report released by RBI, share why Thermal power is not fading away anytime soon and tell you about Jefferies first India long-only equity portfolio. If you want these directly in your mailbox, please subscribe here.

Let’s get started!

The Week, Month and Half Year Gone by…🗓

Markets had a flat week, ending marginally in the red. 

Pharma was the top gainer, indicating a possible recovery, followed by Consumer. Power & Utilities saw correction – down 12% last month.

For 6 months (YTD), Commodities, Power and Industrials are the best performers, indicating revival of old school Capex heavy sectors.

Industry wise snapshot for the last week, month and six months (YTD CY2021)

Continuing with the trend of rally shifting to smaller companies, Micro and Small caps performed well, while Large caps saw a minor retraction.

The same trend reflects in the last 1 and 6 months data, although it’s more stark over the last month.

Is Value Investing (Really) Dead?

Kai Wu of Sparkline Capital believes it’s not – value has not underperformed if one considers Intangible value along with Tangible value

The four largest companies today by market value do not need any net tangible assets. They are not like AT&T, GM, or Exxon Mobil, requiring lots of capital to produce earnings.

– Warren Buffett

Executive summary:
In an interesting memo ‘Intangible Value’, Kai Wu of Sparkline Capital explains the reason value investing has struggled over the past decade is due sole focus on tangible assets and failure to incorporate intangible assets, which play an increasingly crucial role in the modern economy. Assessing value including intangibles will restore value investing to its former glory.

What is value investing?
The classic – buy something at a price lower than its intrinsic value.

When people ask me what value investing is, I say it’s trying to buy a dollar for 75 cents…So what is growth investing? It’s buying 75 cents for a dollar with the expectation that 75 cents becomes $7.50 in time.

– Josh Brown, Ritholtz Wealth Management

We share 10 key takeaways from his paper:

  • Intrinsic value must include intangibles for value investing to remain effective and profitable ie: Intrinsic value = tangible + intangible value
  • Intangibles are eating the world: A sustained shift towards asset light models means that intangibles cannot be ignored; Intangibles contribute up to 45% of US balance sheet now.
  • P/E and P/B only measure tangible aspects: Book value and accounting earnings fail to account for intangibles. P/E & P/B rely on backward looking measures and mostly ignore the future value of intangible investments such as patents and R&D.
  • In order to quantify intangible value, one needs to look beyond the financial statements of a company. 4 sources of Intangible Value/ moats:
    • Brand Equity (customer loyalty, brand recognition, etc)
    • Human Capital (skilled and motivated workforce)
    • Intellectual Property (IP) (patents, data, etc)
    • Network Effects (capability to create an ecosystem around products) 
  • Prefers non-GAAP accounting; GAAP doesn’t record intangibles properly:
    • Brand Equity: Marketing costs not capitalized & lumped in SG&A
    • Human Capital: Some employee costs lumped under SG&A
    • IP: R&D expenses are not capitalized, unless acquired (M&A)
  • Share of Intangibles vary across industries:
    • Tangibles: Real Estate, Utilities, Materials, Energy & Financials
    • Intangible focused: Tech, Healthcare & Communications
Sectors which have tangible value > 50% of their B/S comprise less than 20% of the S&P 500 Market Cap now, down from over 80% in 1960

Chart above shows which intangible matters more across industries.

  • How to measure: Intangibles data is mostly cluttered and New Language Processing (NLP) needs to be used in order to make sense of it
  • The good news is that traditional value investing still works as long as you only invest in companies for which tangible value still matters. The bad news is that the universe of companies for which tangible value still matters is steadily and irrevocably shrinking!
  • As an investor, it is irrational to box yourself within just “value” or “growth”. It is important to adopt a more holistic approach: one based on a broader definition of intrinsic value that can achieve growth at a good price
  • Many investors now seek “growth at any price”. This is common during bull markets but can become dangerous in peak bull markets, as investors don’t have a margin of safety.

If you enjoyed reading this article, you can follow Kai Wu to stay updated.

RBI’s Financial Stability Report: More good than bad

RBI releases a bi-annual report on the financial health of the economy which it calls the “Financial Stability Report”. Given the second wave of Covid that impacted us in March and April, this document becomes pertinent to assess where we stand currently. We summarize key highlights from the 128 page document:

NPA Situation: Under control

The worst case NPA scenario now (severe stress GNPA of 11.2%) is better than RBI’s best case scenario (baseline gross NPA of 12.5%) an year ago.

– Comparison of last 3 financial stability reports
  • Banking GNPA by March 2022: 9.8% under base-case and 11.2% under severe stress (7.5% currently)
  • The stress scenario looks unlikely (only if FY22 GDP growth declines to 6.5%)
  • Restructured assets ratio is at 0.9%, significantly lower than anticipated
  • MSME worst hit, given highest restructured assets and loans given to weaker MSMEs
  • Some NPA concern: CGEM (Construction, Gems & jewelry, Engineering & mining) at 15% and Metals, Infra, power, textiles, etc in double digits
  • Relief measures given post first wave of Covid (moratorium, restructuring, etc) has helped
  • Credit offtake remains slow
  • RBI has carefully managed the yield curve (yields have been kept low) via operations like GSAP and OMOs, and thus banks have been protected against a valuation decline. This ensured that investment/ treasury portfolio of Banks don’t have to take MTM losses.
  • RBI has selected MSME lending as the theme for the third cohort at its regulatory sandbox
  • If you wish to understand more, check our thread on monetary tools used by RBI
  • Net Interest Margin (NIM) is stable at 3.3%; Cost of funds is low at 4.7%; Yield on assets at 7.6%
  • Comfortable Provision coverage ratio at 68.9%
  • Banks are well capitalized after capital raising done in 2020

Insurance sector: High claims settlement

  • During FY 2021, Insurers received 22,205 Covid death claims worth Rs 1,644 cr. Interestingly, 21,854 claims were settled worth Rs 1,492 cr
  • Claims settlement ratio of 98.1-98.6%; this was 1-1.5% higher than FY 2020
  • Premiums collected under COVID-19-specific policies: Rs 1,307 cr (Sum insured: Rs 13.6 lakh cr)

Why Thermal power is here to stay and Why Green Hydrogen matters

There is little doubt that discussions around green and clean energy are increasing globally. And with Reliance Industries announcing large capex plans in this segment, the thesis stands validated in India as well.

However, the transition will not be as quick as anticipated and we found good reasons in these extracts from Cummins India, Q4 FY21 earnings call (link):

Jefferies releases India Long-Only Portfolio:

Christopher Wood, global head of equity strategy at Jefferies has launched India long-only equity portfolio with 16 stocks, and we share details below:

Christopher Woods has selected 16 stocks in his inaugural India only equity portfolio

The portfolio has been put together in consultation with Jefferies head of India research Mahesh Nandurkar.

Highest allocation to Financials (40%), followed by Energy (20%) and Real Estate (17%). Interestingly, Jefferies has no allocation to Pharma and IT segments.

Jefferies believes India is at the start of a new housing cycle after a seven-year downturn, after the mother of all consolidations in the developer industry.

High energy weightage is a hedge against the obvious risk of a higher oil price on Indian financials and other interest rate sensitive sectors.

Quote of the week:

Tweet of the week: Ian Cassel

In other news:

  • With almost half the population fully vaccinated, pent up demand amongst US travelers provides a strong boost to the travel industry. The FAA reported highest air traffic on June 24th: 47,000 flights/24hr period. 
  • COVAXIN concluded its phase 3 trials and reported a 65% efficacy against the delta variant 
  • Vodafone-Idea’s lenders have approached the FM in a bid to secure relief for the telco, which has indicated that it faces a going concern uncertainty in light of inability to raise funds 
  • UP allows multiplexes, cinemas and gyms to open from Monday, July 5th (*fingers crossed*)

That’s all for this week. Please share with your peers if you found this helpful and subscribe at multipie.co to start receiving these as a weekly digest every Saturday!

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