An Analysis Of Indian Small Cap Stocks – ValueWalk Premium

An Analysis Of Indian Small Cap Stocks

A analysis of various Indian stocks by Amrit Mark Brar and Thillai Palanichamy.

Q2 hedge fund letters, conference, scoops etc

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Bank of Baroda

Bank of Baroda (BoB) is an Indian multinational, public sector banking and financial services company. It is owned by Government of India.

It has a very diversified business segments from lending operations to private equity and asset & wealth management.

Recently, public sector banks have been in news for high provisions, deteriorating asset quality and NPAs shooting through the roof which is weighing on their net profits.

On the account of strong growth and stronger future projections, most PSBs took higher exposures towards infra facing corporate resulting in restructures instead of NPAs recognition. As a result, banks are now facing capital deficiencies and are now unable to create new business due to inadequate capital.

Being a PSB, Bank of Baroda also fell into the same situation. Government has promised to save these ailing PSBs but capital infusion itself is not enough. If the lending practices do not improve then infused capital will again result in high provisions, deteriorating asset quality and NPAs shooting through the roof.

Bank of Baroda has made disclosures which shows consistent improvement in incremental disbursement of loans on all lending segments. There has been a dramatic improvement in asset quality in corporate banking, retail banking and MSME banking. The bank’s total NBFC exposure rating is also above par post NBFC crisis of September 2018. Apart from this, the domestic and international NII and NIM are improving with international NIM catching up to domestic margins which might lead to better operating profits.

NII is showing a healthy growth but the provisions are weighing on the net profits, and moreover, the additional capital raising plans are short-term concerns that could hinder the growth of the bank. Before accessing the markets for capital the bank is going to fund growth from internal accruals and ESOP. Showing that business is well now the bank is going to tap markets for capital in Q3. Even if bank is not able to grow its operating profit the decrease in provisions will unlock greater value as presently the provisions for bad loans form around 86% of these provisions.

The bank’s focus has now shifted to a bank target customer approach rather than customer target bank approach. The CASA deposit ratio is 41% and with the government’s push for rural incomes and being a rural and semi-rural facing bank the CASA ratio could further improve improving the operating profitability of the bank.

The merger of BoB, Dena Bank and Vijaya Bank has attracted a lot of attention. Critics are of the view that the merger will decrease the profitability as a result of absorption of two weaker banks by one stronger one. The management declines such views. But even if this were true, the dedication and commitment of the management which can be seen in the disclosures increases the confidence of extracting value from this merger.

Power Finance Corp Analysis

Power Finance can be classified as a government run NBFC focused on funding Power Infrastructure projects. Power sector being a high capex sector makes PFC a good bet with minimal competition. After its merger with REC, the combined entity might gain monopoly over Power sector lending.

It has three major segment lending namely, generation, transmission and distribution with major exposure to generation.

Recent lending trends have shown that there is a pickup in Power lending pickup with the difference between sanctioned and disbursed loans increasing dramatically. This could be due to lack of liquidity but the pickup in sanctioned loans is huge in absolute and percentage terms. Therefore, as a result, the loans which have not been disbursed but have been sanctioned will add to the revenues. Going ahead, the lending growth is stabilizing but the narrowing difference between sanctioned and disbursed loans can generate some short-term above average growth.

The borrowing profile is comfortable and diversified with 90% domestic borrowing, 65% rupee denominated bonds, less dependence on commercial paper and access to low cost funding with one of the few financial institution to be able to raise capital through capital tax bonds. PFC bonds enjoy one of the highest rating in domestic and international markets with rating being equivalent to that of Indian Sovereign rating.

Loan book stands at Rs 3,14,667 cr. The entire government portfolio, 83% of total portfolio, is no stress and regular servicing whereas around 55% of private sector portfolio (17% of total portfolio) is no stress and regular servicing. Therefore, in totality, 91% of loan assets are no stress and regular servicing. Keeping in mind, the incompetence of private sector in power sector, the management has reduced incremental loans to private sector. The management is capable and conservative with a strong focus on resolution of stressed assets and has even provided provisions for assets where recovery is envisaged.

Recently merger of PFC with REC is in the news. The merger has the potential to open new possibilities and growth for PFC. The acquisition price comes out to be 139.5 which is a huge discount on its book value and therefore prove to be a valuable merger to PFC. The acquisition has been funded by 70% of internal cash flows and rest through debt.

There have been concerns raised on post-merger deterioration of capital adequacy ratio to which management has clarified that the capital adequacy ratios have actually improved and as the power plants get commissioned the risk weight to those assets would decrease which would further lead to favorable capital adequacy ratios.
PFC is a perfect mix of monopolistic operator, depressed valuations, possible turnaround, capable and conservative management, improving asset quality, diversified borrowing profile and valuable merger. The government’s push for infra could further boost the future prospects of Indian Power Sector.

Recovery mode ON Federal Bank

Federal Bank is a Private Sector Scheduled Commercial Bank in India headquartered in Kochi, Kerela. With a customer base of eight million and a large network of remittance partners across the world, Federal Bank claims to handle more than 15% of inward remittances.

Bank has both segments retail as well as wholesale with focus on wholesale. The bank management has said that the focus will shift to retail as that is where the growth is coming from.
Recently, Federal Bank has been in news for its high NPA ratios which is not healthy for any bank. NPAs lead to higher provisions, lower revenues, higher costs and finally decrease in net profit affecting the EPS growth.

The bank has been gripped with the sectoral challenge of increasing NPAs, especially corporate facing banks. It had Stressed book to total average assets ratio of 4.30% in Q1 16 which the bank has brought down to 1.96% in Q3 19 which is a major decrease in stressed assets. Along with this, the restructured loans have been brought down from Rs 2583 cr to Rs 644 cr over the same period. This is accompanied with rise in net NPA amounts from Rs 484 cr to Rs 1817 cr. Coupled with increase of “A” and above rated loan book from 65% to 72%, increase in asset quality, it all signals towards peaking of NPA cycle and healthy growth in future can be expected. Sectoral challenges in NBFCs and PSBs to also aid to higher growth in private sector banks.

Bank has taken digital initiatives to increase its market share. Active digital users are growing 45% YoY with FedMobile transaction volume clocking 92% YoY. Digital share of the bank has been improving.

The value in the bank lies in its digital initiatives, peaking of NPA cycle, improvement in asset quality, healthy CASA deposits and growth. Third-party products still form a very small portion of total income and therefore, immense value lies in this segment of Federal Bank.

Federal Bank on the weekly charts has made a double bottom at levels close to 95-99, after making a high of 127 in 2017. It has been consolidating at these levels for the past 12-14 months, and any move above 99 would make a fresh case for a retest of its previous highs of 127.

The longer term charts suggests a good move on the upside. In terms of price action, the stock has made a classic reversal on the Fibonacci retracement indicator, which reinforces the fact that the move from 127 to 75 odd levels was just a routine correction (remember the stock moved from 42 to 127 in a span of one year) and now the stock appears to be making a base at 95, and if this time correction holds on for a few more days, fresh entry can be taken. Alternatively any slight dip to 93 or 88 levels presents an attractive entry point.

Analysis on Allcargo Logistics

Allcargo is an integrated logistics solutions provider. It operates within three major segments which are Multimodal Transportation Operator, CFSs & ICDs, Project Engineering.

The Multimodal Transportation Operations form a major chunk of revenues which is around 75%-80%. The global MTO segment is growing around 3%-4% whereas Allcargo’s MTO volumes are growing around 9%-10%. This segment is the major revenue earner but contributes least to the EBIT margins than the other two segments. The growth in MTO segment is influenced by the growth in global & domestic trade. A significant pick up in global trade can be expected as major central banks are shifting from tightening to accommodative monetary policies.

CFS & ICD segment of the company forms a major chunk of its EBIT margin. The segment has grown slowly over the last 7-8 years on the account of weak macroeconomics and introduction of DPD in 2016-17. Management has stated in the annual report that volumes in DPD have stabilized and should not hit the CFS &ICD segment volumes further. Moreover, Indian government has also taken initiatives for DPD and CFS to co-exist as CFS & ICD are major employers in India.

Project & Engineering is another major contributor to EBIT margins but is dragging the overall growth of the revenues as the segment is influenced by growth in capex. Failure in capex revival has negatively impacted this segment. The capacity utilization peaked in 2012 with 80% and has been falling since then and currently stands at 76%. The capacity utilization has to increase for capex cycle to revive. Management has stated that the drag in P&E segment can also be attributed to certain headwinds in wind energy sector which will not crop up going forward. Management is positive on the performance of this segment as it has seen some major pick up in orders from infra sector.

In short, Allcargo’s performance is positively correlated with global trade growth, capacity utilization and capex cycle. Revival in these factors, as expected, will positively impact revenue growth along with margin expansion which will further unlock value for shareholders in this beaten down stock.

Management has taken various initiatives to tackle the sectoral challenges like introduction of logistics park in Jhajjar to aid MTO volumes, leasing CFS facilities at Kolkata and discontinuation of non-value creating Mudra lease to support CFS segment, tackle the effect of DPD at JNPT port and introduction of asset-light model in P&E segment. Some government initiatives like assigning infra sector status to Logistics will aid in boosting Logistics sector.

After making a high of 221 in 2017, the stock has hit a new low of 92, before making a bounce to 117 and on the weekly charts has made a very strong bottom. In fact, the stock has never spent reasonable time at these levels of 110-120.

On the daily charts, a resistance of 127 can be seen and if that were to get taken out a strong rally is in the offing. The fact that the stock is close to its 200DMA offers a great risk reward ratio. RSI too has made a bottom.

IDFC First Bank

IDFC First Bank is an entity created by the merger of IDFC Bank and Capital First Management and will be under the management control of the latter.

Capital First is a non-banking finance company (NBFC) which is engaged in consumer financing business which includes financing consumer purchases like phones, electronics, etc.

Under the leadership of V. Vaidyanathan, Capital First has been able to enjoy Asset under Management growth of 29% and profit growth of 39% since 2013 with focus on retail lending.

Whereas IDFC has a very low retail portfolio and with only 15% in retail and over 60% in infrastructure and corporate loans.

In the recent liquidity crisis, NBFCs with credible and known promoters got the funding while others were left out.

Dried up funds result in fewer loan disbursements which further translates into lesser earnings and business.

NBFCs have higher rate of acquiring funds than banks because deposits with NBFCs are not insured and also because they don’t have access to CASA (Current and Savings Account) deposits.

IDFC First Bank is ahead of its competition after its merger. IDFC has banking license which Capital First can leverage to get an access to cheaper funding than other NBFCs.

Consumer financing is a less competitive market and IDFC First Bank will use the cheaper source of funding to operate in less competitive markets by getting access to CASA deposits. The combined entity will have a 32% in retail portfolio which they want to scale up to 70%, the management also wants to bring down the infrastructure portfolio to 0% and keep the corporate loans to 30%.

We will see higher NIMs (Net Interest Margins) in this new merged entity because of cheaper funding. Due to increase base in no of middle class numbers and focus from present budget, on consumption we might even see growth in loan volumes as well. Capital First has also kept its net NPAs around 0% which is again a very healthy sign. Expansion in NIM, growth in volumes and 0% NPAs is perfect in making IDFC First Bank a good buy.

IDFC Bank has seen significant underperformance vis a vis other banking cos, which now trade at 2-3 times book, whereas IDFC first trades at 1.14 times book.

Technically, the stock has made a strong bottom at 37-40 kind of levels and at the same time any move above 47 could take it to newer highs.

The stock has made a huge sideways movement for the past 2-3 years and any breakout would be strong and sustainable.

Take Solutions

Take Solutions (TS) is an Indian IT company operating within two verticals which are Supply Chain Management and Life Sciences. They are trying to convert it into a primarily Life Sciences Company defocusing from SCM.

TS’s revenues were significantly hit from the period 2013-15 after which they bounced back. The decline in revenues has been due to decline in revenues from SCM vertical and that from Life Sciences are increasing YoY. Major revenue is from US and is increasing YoY.

TS is a service based company and assists Pharma companies with their clinical researches using techniques like Data Analytics. Their product has good future prospects as with the introduction of new drugs US Pharma industry is expected to grow.

Company has adopted inorganic growth strategy through acquiring similar companies. While acquiring companies it has not increased debt or equity base significantly with acquisitions being cash based. Another positive in recent acquisitions it has used preferential allotment to existing promoters which has increased promoter holding to 66.8%.

TS has healthy fundamentals with low debt position, healthy cash flows.

Recently, there were concerns raised over decreased revenues and earnings in previous quarter. The management has clarified that the decrease in earnings is on the account of $1 million of forex loss and $1.5 million of acquisition related expenses. The forex is not in control of the company but the acquisition will start adding to the bottom line.

On the technical front, TS looks extremely beaten down after having corrected from levels of 307, and the stock seems to have bottomed out at current levels on the monthly charts.

Even on the daily charts, the RSI suggests that upside momentum is slowly returning and any move above 160 would confirm this strong uptrend, very recently the stock closed above its 100 day moving average and given the positive chart structure, stock is expected to test levels of 168-170 which is the 200 day moving average.

From a slightly longer time horizon, the levels to watch out would be 162,168 and if that were to be taken out 180 is the zone to watch for.

TS becomes perfect combination of strong fundamentals & leadership, attractive valuations and sound technical.

Article by Amrit Mark Brar & Thillai Palanichamy 


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