Logic Behind Our Rebalance Decisions – Mar 2024 Edition

At times, our users inquire about the logic behind including or excluding certain stocks from our smallcases. We’ve handpicked a few examples to shed light on this and will guide you through our decision-making process. Before we delve into these decisions, it’s essential to understand that our primary aim is to minimize portfolio churn, intending to hold stocks for the long term.

Thematic/Non-Model smallcases

Transporting India

Removed: TCI Express

TCI Express has revised its volume growth guidance downward, anticipating an overall growth of just about 3-4% for FY24. This adjustment reflects a significant decline from the previously expected growth of 13-14%. The main reason behind this downward revision is the challenges faced in implementing price hikes due to subdued demand. Factors such as elections and a broader economic slowdown have contributed to weak discretionary spending, further impacting volume growth.

The situation is further complicated by the aggressive pricing strategy adopted by competitors, aiming to capture market share in a fiercely competitive landscape. Additionally, real-world challenges, such as protests in North India causing significant disruptions, add another layer of complexity to TCI Express’s operations.

Added: Delhivery

Delhivery is experiencing a significant upturn, benefiting greatly from a robust e-commerce revival. Positioned as a key player, the company is capitalizing on the growing disparity between e-commerce and traditional retail growth. This success is partly attributed to a better-than-expected return on technology investments, particularly in route planning and capacity management, which have enhanced operational efficiencies.

Three main factors contribute to Delhivery’s strong performance: 

1. Achieving scale efficiencies amidst resurgent demand, 
2. Gaining market share as competitors adjust pricing and Delhivery continues to optimize its network, and 
3. Expanding its Part Truckload (PTL) customer base, marked by increased participation from MSMEs. Notably, the company has recorded positive Profit After Tax (PAT) for the first time since its IPO listing, marking a significant milestone.

Delhivery’s management is optimistic about the e-commerce industry, expecting growth to remain in the 15-20% range for the foreseeable future. Growth in metros and the top 20 cities is primarily driven by increasing user frequency. In contrast, both frequency and the influx of new users are spurring expansion in tier 2 and beyond cities, highlighting Delhivery’s strategic positioning to capitalize on these trends.

Brand Value & The Great Indian Middle Class

Removed: Jubilant Foodworks

The Quick Service Restaurant (QSR) industry has faced challenges with demand over the past four quarters due to persistent food inflation. Within the QSR sector, the pizza category has been particularly affected by high milk and cheese prices, which are essential ingredients for pizzas. As a result, Jubilant Foodworks (JUBI) has experienced a continuous decline in Same Store Sales Growth (SSSG).

Furthermore, the company’s overall revenue growth has been reliant on store additions, which could strain its balance sheet in the future. Given these industry-wide challenges and specific growth issues Jubilant Foodworks faces, we have decided to remove it from our portfolio.

Banking Privately 

Reduced Weightage: HDFC Bank

HDFC Bank has historically maintained a Net Interest Margin (NIM) of 4-4.3%, but in recent quarters, its NIM has come under pressure. In the December 2023 quarter, the bank had to bolster its NIM by selling excess investments in government securities (Gsecs). Without this action, the decline in NIM would have been more pronounced. 

Sluggish deposit growth has left the bank with limited liquidity, forcing it to borrow at high rates from the wholesale market to finance its loans. However, stiff competition in the market prevents the bank from increasing loan charges, further impacting its NIM outlook negatively.

It is believed that  HDFC Bank’s re-rating and performance hinges on achieving a 20%+ growth in its pre-provisioning operating profit, driven by improved margins and lower operational costs, rather than relying on the sale of investments. However, the days of maintaining a 4.2% NIM may be coming to an end, especially with the addition of a 7 trillion rupee home loan book, which typically yields lower margins.

Considering these challenges, and uncertainty about HDFC Bank’s earnings growth shortly, we have reduced the weightage of the bank. 

Bringing the Bling

Removed: Jubilant Foodworks

The Quick Service Restaurant (QSR) industry has faced challenges with demand over the past four quarters due to persistent food inflation. Within the QSR sector, the pizza category has been particularly affected by high milk and cheese prices, which are essential ingredients for pizzas. As a result, Jubilant Foodworks (JUBI) has experienced a continuous decline in Same Store Sales Growth (SSSG).

Furthermore, the company’s overall revenue growth has been reliant on store additions, which could strain its balance sheet in the future. Given these industry-wide challenges and specific growth issues Jubilant Foodworks faces, we have decided to remove it from our portfolio.

Added: Ethos

We’ve been tracking Ethos for the past year, and despite facing challenges in discretionary spending, the company has managed to achieve growth. Ethos holds a monopoly in watch retailing for many high-end brands, positioning it uniquely in the market. The recent announcement regarding the European Free Trade Agreement (FTA) is anticipated to be advantageous for Ethos, as it will lead to a significant drop in import duties.

Added: 360 ONE WAM Limited

360 ONE WAM Limited is a wealth management company focused on the affluent class. It has been witnessing a steady rise in AUM. Both the top line and bottom line of the company have been growing. Its upcoming launch of exclusive High Net Worth Individual (HNI) coverage by Q1FY25 further enhances its appeal as an investment opportunity.

Electric Mobility 

Added: Exide Industries 

Exide Industries Limited is primarily known for its production, marketing, and sale of lead acid storage batteries, which find applications across various sectors including automotive, power, telecom, infrastructure projects, computer industries, railways, mining, and defense. Notably, a significant portion of its revenue, approximately 52%, is derived from the automotive industry, with the remainder coming from inverters and industrial applications.

As the automotive industry undergoes a transition towards electric vehicles (EVs), there is an anticipated decrease in demand for lead-acid batteries. In response to this market shift, Exide Industries is diversifying its product portfolio by venturing into the manufacturing of lithium-ion batteries. To facilitate this diversification strategy, the company has established a subsidiary in Bengaluru, which is in the process of setting up a lithium-ion battery factory with a capacity of 12 gigawatt-hours (GWh) at an estimated cost of Rs. 6,500 crore.

The first phase of this expansion plan is projected to be operational by 2025. Additionally, Exide Industries is already operating a module pack and assembly line factory with applications relevant to electric vehicles. This strategic move underscores the company’s proactive approach to adapt to evolving market trends and capitalize on the growing demand for lithium-ion batteries driven by the shift towards electric mobility.

Tracker smallcases

Infra Tracker

Added: NTPC

NTPC Renewable Energy (RE) aims to contribute 12% to India’s RE capacity by 2030 and 50% to its capacity. With an 18% market share in RE capacity auctions, NTPC is a major player in the sector. In the near term, it plans to add 1GW by FY24 and 3GW by FY25 to its existing 3.3GW capacity. NTPC’s expertise in thermal power generation allows it to benefit from RE additions, as it can adjust thermal supply to ensure off-take from renewable assets, leading to better tariffs. 

NTPC, as a government-owned company (PSU), can borrow money more cheaply than private firms, which boosts the profitability of renewable energy projects. This advantage helps NTPC manage risks and improve its financial performance in renewable energy.

The company offers a stable dividend yield (~2%) and has a low PE ratio. The Power sector, especially power generation and renewables, receives the highest allocation of capex according to the National Infrastructure Pipeline (NIP), favoring NTPC’s growth.

Added: Titagarh

Titagarh Industries has a yearly capacity of 10-12k units, making it one of India’s few integrated manufacturers of passenger rail systems. It has a strong track record of securing long-term orders such as Vande Bharat and metro projects, making it well-positioned to benefit from railway investments and Dedicated Freight Corridors (DFCs).

The company holds the largest market share in total tenders from FY20-23 (around 25-30%) in wagons and operates factories in India and France through Firema. Partnerships with multinational companies further strengthen its capacity expansion plans to meet growing demand in the sector. With a low debt-to-equity ratio, Titagarh has room for debt-funded growth. 

In the freight segment, its order backlog of ₹ 13,600 Cr provides revenue visibility of 3.6 times the trailing twelve months (TTM). The freight segment is expected to deliver a revenue compound annual growth rate (CAGR) of 33%, contributing over 90% to profit after tax (PAT) with a targeted return on equity (ROE) of 17%.

Added: Jupiter Wagons

Jupiter Wagons Ltd (JWL) stands as a key player in the wagon manufacturing sector, poised to benefit from railway infrastructure investments and Dedicated Freight Corridors (DFCs). With a notable 13% market share in wagons, JWL is strategically positioned to capitalize on railway capital expenditure.

The company maintains a favorable debt-to-equity ratio, providing ample room for growth through debt financing. Currently capable of producing 7,000 wagons per year, JWL aims to enhance its capacity to 12,000 wagons annually by 2025.

With a substantial total order backlog of ₹7000 crore, comprising 60% from private orders and 40% from Indian Railways orders, JWL enjoys revenue visibility for the next 2.2 years. It anticipates a robust 41% revenue compound annual growth rate (CAGR) from FY23 to FY26, targeting a return on equity (ROE) of 23%.

JWL aims to sustain a margin of over 13% in the medium term, supported by backward integration of freight components and brakes, coupled with high capacity utilization.

Removed: KNR Constructions

KNR Constructions has faced challenges with a critically low order book, especially in the Build-Transfer-Build (BTB) segment. Despite efforts to secure new orders and diversify, the company has struggled, resulting in reduced order inflow forecasts and significant margin contraction.

Pharma Tracker

Removed: Suven Pharma

Suven Pharma is facing challenges due to reduced demand in its CDMO specialty chemicals and pharma sectors, resulting in disappointing quarterly performance. This situation is worsened by global de-stocking and cyclical headwinds, leading to elevated valuations. Management expects these challenges to persist in the near term, affecting the company’s immediate outlook.

Additionally, the proposed merger with Cohance Life Sciences introduces new risks, especially in API exposure, at a time when market conditions are unfavorable. Overall, the outlook remains subdued due to a tough macro economy, limited budgets for large global pharma firms, and reduced VC funding for biotech.

Added: Mankind Pharma

Mankind Pharma has become the fourth-largest player in the Indian Pharma market, up from eighth in FY12, due to effective brand-building and growth in acute and chronic sectors. Strong financials enable strategic mergers and acquisitions. 

By focusing on metropolitan areas and tier-1 cities, the company has been able to tap into high-potential markets and establish a strong presence. Also, its strategy is its adoption of a low-price model, allowing it to offer significant discounts compared to competitors. This approach has made its products more accessible to a wider range of customers, contributing to its growing popularity.

Additionally, Mankind Pharma’s recent increase in stake within the company demonstrates its commitment to further expansion and development, signaling confidence in its prospects within the pharmaceutical industry.

Banking Tracker 

Reduced Weightage: HDFC Bank

HDFC Bank has historically maintained a Net Interest Margin (NIM) of 4-4.3%, but in recent quarters, its NIM has come under pressure. In the December 2023 quarter, the bank had to bolster its NIM by selling excess investments in government securities (Gsecs). Without this action, the decline in NIM would have been more pronounced. 

Sluggish deposit growth has left the bank with limited liquidity, forcing it to borrow at high rates from the wholesale market to finance its loans. However, stiff competition in the market prevents the bank from increasing loan charges, further impacting its NIM outlook negatively.

It is believed that  HDFC Bank’s re-rating and performance hinges on achieving a 20%+ growth in its pre-provisioning operating profit, driven by improved margins and lower operational costs, rather than relying on the sale of investments. However, the days of maintaining a 4.2% NIM may be coming to an end, especially with the addition of a 7 trillion rupee home loan book, which typically yields lower margins.

Considering these challenges, and uncertainty about HDFC Bank’s earnings growth shortly, we have reduced the weightage of the bank. 

Added: Canara Bank

Canara Bank Ltd. operates as a banking company with various segments including Treasury Operations, Retail Banking Operations, Wholesale Banking Operations, and Other Banking Operations. The bank has recently been growing its top line and bottom line at a rapid pace, signaling its operational efficiency and effectiveness in generating profits.

Notably, Canara Bank boasts a high capital adequacy ratio, indicating its strong financial position and ample capital reserves. This ensures the bank’s ability to absorb potential losses and meet regulatory requirements. 

One of the key highlights of Canara Bank’s performance is its success in reducing the percentage of non-performing assets (NPA), which is indicative of its prudent credit management and risk mitigation strategies. This improvement in asset quality has contributed to maintaining a steady net interest margin (NIM), reflecting the profitability of its core lending activities.

Despite its strong fundamentals and positive financial indicators, Canara Bank’s stock has been trading at a notable discount to the sector price-to-earnings (PE) ratio. This suggests that the market may not fully reflect the bank’s intrinsic value, potentially presenting an attractive investment opportunity for investors seeking undervalued stocks. Moreover, the bank has been experiencing high price momentum, indicating bullish sentiment and investor confidence in its growth prospects.

Overall, Canara Bank’s sound financial position, robust operational performance, and favorable market valuation metrics position it as a compelling investment option within the banking sector.

End Note

Ensuring transparency with our investors is at the core of our values. We aim to align our management approach with your expectations by offering comprehensive insights into our rebalance decisions. Your understanding of our outlook on managing smallcases is essential to us, and we are dedicated to continuously refining our strategies for your benefit. Thank you for your trust and partnership as we navigate the financial landscape together.

Until our financial paths cross again ✌️

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The content in these posts/articles is for informational and educational purposes only and should not be construed as professional financial advice and nor to be construed as an offer to buy /sell or the solicitation of an offer to buy/sell any security or financial products.Users must make their own investment decisions based on their specific investment objective and financial position and using such independent advisors as they believe necessary.

Windmill Capital Team: Windmill Capital Private Limited is a SEBI registered research analyst (Regn. No. INH200007645) based in Bengaluru at No 51 Le Parc Richmonde, Richmond Road, Shanthala Nagar, Bangalore, Karnataka – 560025 creating Thematic & Quantamental curated stock/ETF portfolios. Data analysis is the heart and soul behind our portfolio construction & with 50+ offerings, we have something for everyone. CIN of the company is U74999KA2020PTC132398. For more information and disclosures, visit our disclosures page here.