Hope you all are doing well and taking proper precautions.
In the light of the Covid-19 led crisis, today we are going to discuss Risk Categorization of the stocks.
We believe it’s an important exercise that every investor should carry out on his/her portfolio stocks to determine the pockets where the risks could originate from. We did so recently and have shared the details below.
We think it should be quite obvious that for most of the companies FY 21 will be a washout in terms of earnings. Already, the lockdown stands extended till May 3rd 2020 and even if the same is lifted from 4th May’20, it will be in phases. Also, the resumption of production and the improvement in demand will be gradual.
So, in our view, more than the earnings, the primary focus at this point of time should be on whether the companies will be able to survive the lockdown and the next few quarters (we hope it’s only 1-2 quarters) of very tepid demand. Yes, with almost zero sales since the end of Mar’20 (for most of the companies) and there still being certain fixed costs, interest expenses and loan repayments to account for, the strength of the balance sheet becomes more important than ever.
While the first order thinking suggests that FMCG, Pharma, healthcare, etc will be the least impacted and therefore one should look at only such sectors for investment. That might prove to be true; however, returns on stocks are a function of both the growth and the valuations and therefore at least we don’t intend to stop looking at quality balance sheets in beaten down sectors, even though the next few quarters may not exactly be hunky dory for them.
Why do we think it’s important to look at quality balance sheets in beaten down sectors?
Just an example: In the metal alloys space, we have covered Maithan Alloys. Now, steel demand is likely to suffer and thereby the demand for alloys is also likely to go down over the next few quarters.
However, to a certain extent the correction in stock prices and the valuations are already reflecting the pain of the sector. Further, what could work in favour of a company like Maithan Alloys which is sitting on 600 crore + cash surplus (against current market cap of 1,070 crore) is that most of the other players in the segment are either leveraged or were reporting losses even before the Covid-19 led crisis.
With lower demand and liquidity issues, their problems will only compound and some may even go out of business.
Thus, even though the size of the market may shrink in the interim, stronger companies could end up gaining higher market share in their respective industries.
Now, coming back to the stocks under our coverage, we have tried to categorize them in three categories, purely based on their balance sheet strength and the nature of the industry (debt equity, interest coverage ratio, discretionary, non-discretionary, etc).
At this point of time, it’s all too difficult to make assumptions about the survivability of the businesses based on their presumed fixed costs and the near-term demand and we leave that exercise to when the companies announce their Mar’20 results and share their plans for the future.
Also, the categorization has got nothing to do with the expected future returns from the stocks. This is just a preliminary exercise to determine where the problems could emanate from if the situation doesn’t improve or continues as is.
If required, we will make the necessary changes to the ratings in the upcoming results season. For the moment, there are no changes.
Note: The names of the stocks have not been disclosed here as part of Premium Subcription. If interested, you can check the details at the following LINK
In the low risk category are mostly the ones with zero or negligible debt and had decent surplus cash at the end of Sep’19 quarter. One pharma company’s debt equity ratio is relatively higher at 0.77; however, it falls under essential category and therefore we don’t foresee any liquidity related issues with the company.
In the mid-risk category, again the balance sheets are strong; however, in order to differentiate them from cash rich, debt free balance sheets, we have categorized them in mid-risk category. Even for leveraged entities like Gold Loans and Housing Finance Companies, we believe they are relatively better placed than other NBFCs because of their focus on gold loans and salaried customers respectively.
We would have categorized Gold loan company as Low risk if it was only focused on Gold loans; however, on account of 21% exposure (in terms of AUM) to Microfinance, we have kept it in mid-risk category.
Out of 20, we believe there are 4 stocks that fall in slightly high-risk category. While all the 4 companies had adequately capitalized balance sheets for the normal times and had in fact started deleveraging even before the crisis began, but considering the fact that their products are discretionary in nature (barring Packaging company), we have kept them in high-risk category.
Before we jump to the conclusion that high-risk stocks should be sold, it is important to take into account the fact that Packaging company resumed operations from 3rd Apr’20 onwards and the consumer durables company resumed operations from 14th Apr’20 to fulfil the backlog of export orders.
Even for other companies in the high-risk category, we believe they could benefit from some shift in global supply chain from China to India and have therefore kept the rating unchanged for the time being.
As we have mentioned this often in the last 2 months, rather than thinking of the top-3 or top-5 stocks, it’s important to spread one’s investments across the stocks and sectors. In our view, the uncertainty of the situation doesn’t lend itself well to building over concentrated 3-5 stocks portfolios.
Wish you good health and wealth.
Disclosure: I have personal investment in Maithan Alloys.
Ph.: +91-727-5050062, Mob: +91-9818866676
Email: [email protected]
Research Analyst Details
Name: Ekansh Mittal Email Id: [email protected] Ph: +91 727 5050062
Analyst ownership of the stock: In Maithan Alloys
Details of Associates: Not Applicable
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Disclosure (SEBI RA Regulations)
Whether the research analyst or research entity or his associate or his relative has any financial interest in the subject company/companies and the nature of such financial interest – Yes, investment in Maithan Alloys
Whether the research analyst or research entity or his associates or his relatives have actual/beneficial ownership of 1% or more securities of the subject company (at the end of the month immediately preceding the date of publication of the research report or date of the public appearance) – No
Whether the research analyst or research entity or his associate or his relative has any other material conflict of interest at the time of publication of the research report or at the time of public appearance – No
Whether it or its associates have received any compensation from the subject company in the past twelve months – No
Whether it or its associates have managed or co-managed public offering of securities for the subject company in the past 12 months – No
Whether it or its associates have received any compensation for investment banking or merchant banking or brokerage services from the subject company in the past 12 months – No
Whether it or its associates have received any compensation for products or services other than investment banking or merchant banking or brokerage services from the subject company in the past 12 months – No
Whether the subject company is or was a client during twelve months preceding the date of distribution of the research report and the types of services provided – No
Whether the research analyst has served as an officer, director or employee of the subject company – No
Whether the research analyst or research entity has been engaged in market making activity for the subject company – No