Pan-Asia Index Rebalances/ Events/ Delta One, Periscope Analytics

Brian Freitas

Pan-Asia Index Rebalances/ Events/ Delta One

Event-Driven

The Indian mutual fund industry has assets of almost INR 5 trillion across Multi cap, Large Cap, Large and Mid Cap, Mid Cap and Small Cap equity schemes. Equity schemes classified as large cap need to have at least 80% of their assets invested in large cap stocks, large and mid cap schemes need to have at least 35% of their assets in large cap stocks and at least 35% in mid cap stocks, mid cap funds need to hold at least 65% of their assets in mid cap stocks, and small cap funds need to hold at least 65% of their assets in small cap stocks.The Association of Mutual Funds in India (AMFI) publishes the list of the stocks in each market cap segment in January and July each year and mutual funds have one month to rebalance their portfolios to adhere to the new categorization.In the upcoming recategorization in January 2021, we see 6 stocks moved from the mid cap segment to the large cap segment with an equal number of stocks moving the other way, and 12 stocks are expected to move from the small cap segment to the mid cap segment with the same number moving the other way. There are quite a few IPOs that will join the small cap list, with just 1 joining the large cap list and 1 joining the mid cap list.Historically, the stocks migrating upward to a higher market cap segment have outperformed stocks that migrate to a lower market cap segment over the 1 month and 2 month period post the publishing of the AMFI list. This can be attributed to fund managers realigning their portfolios to meet the new categorization. This provides opportunities to pre-position for the move and unwind post the announcement of the reclassification.

The Indian mutual fund industry has assets of almost INR 5 trillion across Multi cap, Large Cap, Large and Mid Cap, Mid Cap and Small Cap equity schemes. Equity schemes classified as large cap need to have at least 80% of their assets invested in large cap stocks, large and mid cap schemes need to have at least 35% of their assets in large cap stocks and at least 35% in mid cap stocks, mid cap funds need to hold at least 65% of their assets in mid cap stocks, and small cap funds need to hold at least 65% of their assets in small cap stocks.The Association of Mutual Funds in India (AMFI) publishes the list of the stocks in each market cap segment in January and July each year and mutual funds have one month to rebalance their portfolios to adhere to the new categorization.In the upcoming recategorization in January 2021, we see 6 stocks moved from the mid cap segment to the large cap segment with an equal number of stocks moving the other way, and 12 stocks are expected to move from the small cap segment to the mid cap segment with the same number moving the other way. There are quite a few IPOs that will join the small cap list, with just 1 joining the large cap list and 1 joining the mid cap list.Historically, the stocks migrating upward to a higher market cap segment have outperformed stocks that migrate to a lower market cap segment over the 1 month and 2 month period post the publishing of the AMFI list. This can be attributed to fund managers realigning their portfolios to meet the new categorization. This provides opportunities to pre-position for the move and unwind post the announcement of the reclassification.

India: AMFI Stock Categorization Changes to Drive Active Portfolio Churn

Value investor- India mid & small caps

Bhaskar Chakraborty

Equity Bottom-Up

<ul><li>Crompton chooses to defend margins while competitors chase growth</li><li>Crompton claims it grew in line with end consumption; it claims competitors resorted to channel filling which is not brought out by V-Guard and Bajaj Electrical's reported numbers</li><li>Growth will slow down in 1HFY18 on GST transition owing to channel de-stocking</li><li>GST will lead to price increases by the organized sector, undermine the 'organized sector to gain market share' thesis</li><li>Valuations leave limited upside, GST transition impact on earnings could create better entry points</li></ul>

Crompton chooses to defend margins while competitors chase growthCrompton claims it grew in line with end consumption; it claims competitors resorted to channel filling which is not brought out by V-Guard and Bajaj Electrical's reported numbersGrowth will slow down in 1HFY18 on GST transition owing to channel de-stockingGST will lead to price increases by the organized sector, undermine the 'organized sector to gain market share' thesisValuations leave limited upside, GST transition impact on earnings could create better entry points

India Consumer Electrical: Key Takeaways from 4QFY17 Results

V-Guard Industries Ltd / Equity Bottom-Up

<ul><li>Grows 4QFY17 revenues 21.4% YoY on revival in post-demonetization demand in north India. Channel filling did not drive revenue growth unlike Havells as V-Guard improved its working capital cycle YoY.</li><li>EBITDA margin falls 280bps YoY on 190bps lower gross margin as price hikes required to defray commodity cost increases were staggered and delayed to tide over demonetization.</li><li>Reports double digit revenue growth in all products except cables in FY17. Grows FY17 EPS 35% YoY.</li><li>Grows non-South revenues 21% YoY, faster than 13% growth in South revenues on growing penetration in non-South.</li><li>Guides to 15% revenue growth in FY18 in the backdrop of expected destocking in the channel owing to GST implementation. Expects margins to sustain at FY17 levels in FY18.</li><li>Per management, GST rate of 28% on all their products is significantly higher than the 21-22% effective currently. This will widen the price gap between an organized player like V-Guard and an unorganized player from 25% currently to 32-35% effective 1st July 2017. So, market share shift to organized sector is unlikely.</li></ul>

Grows 4QFY17 revenues 21.4% YoY on revival in post-demonetization demand in north India. Channel filling did not drive revenue growth unlike Havells as V-Guard improved its working capital cycle YoY.EBITDA margin falls 280bps YoY on 190bps lower gross margin as price hikes required to defray commodity cost increases were staggered and delayed to tide over demonetization.Reports double digit revenue growth in all products except cables in FY17. Grows FY17 EPS 35% YoY.Grows non-South revenues 21% YoY, faster than 13% growth in South revenues on growing penetration in non-South.Guides to 15% revenue growth in FY18 in the backdrop of expected destocking in the channel owing to GST implementation. Expects margins to sustain at FY17 levels in FY18.Per management, GST rate of 28% on all their products is significantly higher than the 21-22% effective currently. This will widen the price gap between an organized player like V-Guard and an unorganized player from 25% currently to 32-35% effective 1st July 2017. So, market share shift to organized sector is unlikely.

V-Guard 4QFY17- Strong Growth, Lower Margins; GST Springs Negative Surprise

<ul><li>Crompton Consumer (CROMPTON IN) shares a number of business attributes with its smaller rival V-Guard (VGRD IN)- namely a long growth runway on the urbanization theme, a diversified portfolio of products, an asset-light business model with very high return ratios (best in the industry) and superior free cashflow generation.</li><li>Crompton’s brand is stronger than V-Guard’s. However, its brand strength doesn’t allow it a pricing premium, rather a reduction in customer search and conversion cost and a tight working capital cycle.</li><li>Failure rates in consumer electrical products are very high. We can’t emphasize how creditable it is on V-Guard’s part to have created 6 successful products. In contrast, Crompton’s appliances business has failed to scale and remains smaller than a single product in V-Guard’s portfolio. Even in fans where Crompton is the market leader, it was beaten to the BLDC fan that consumes 50% less power by Orient.</li><li>Crompton has the widest retail reach. While this is a key strength, we see limited upside from increased penetration. V-Guard with less than a sixth of Crompton’s points of presence has significant headroom to increase penetration in non-South markets.</li><li>We think Crompton’s portfolio faces meaningful risk of disruption from Energy Efficiency Services Ltd (EESL). EESL is tendering lighting, fans and pumps (these three comprise 94% of Crompton’s revenues) where tender prices have declined impacting margins. In contrast, V-Guard does not participate in EESL tenders as it has enough room to grow in the country.</li></ul>

Crompton Consumer (CROMPTON IN) shares a number of business attributes with its smaller rival V-Guard (VGRD IN)- namely a long growth runway on the urbanization theme, a diversified portfolio of products, an asset-light business model with very high return ratios (best in the industry) and superior free cashflow generation.Crompton’s brand is stronger than V-Guard’s. However, its brand strength doesn’t allow it a pricing premium, rather a reduction in customer search and conversion cost and a tight working capital cycle.Failure rates in consumer electrical products are very high. We can’t emphasize how creditable it is on V-Guard’s part to have created 6 successful products. In contrast, Crompton’s appliances business has failed to scale and remains smaller than a single product in V-Guard’s portfolio. Even in fans where Crompton is the market leader, it was beaten to the BLDC fan that consumes 50% less power by Orient.Crompton has the widest retail reach. While this is a key strength, we see limited upside from increased penetration. V-Guard with less than a sixth of Crompton’s points of presence has significant headroom to increase penetration in non-South markets.We think Crompton’s portfolio faces meaningful risk of disruption from Energy Efficiency Services Ltd (EESL). EESL is tendering lighting, fans and pumps (these three comprise 94% of Crompton’s revenues) where tender prices have declined impacting margins. In contrast, V-Guard does not participate in EESL tenders as it has enough room to grow in the country.

Crompton Consumer or V-Guard: Which Do We Prefer

<ul><li>A brand business on the urbanization theme- a very long runway. Brand strength illustrated by improving profitability and reduction in working capital cycle.</li><li>South-India based electrical appliances maker with a portfolio of six successful products. None other than the market leader (Havells) has such a diversified portfolio.</li><li>Large room to improve distribution in non-south geographies that contribute 33% of revenues now (9% in FY09). Non-south revenue per distributor is 1/4th of that of south-based distributor indicating large mining opportunity and better growth outlook.</li><li>Business requires little capex to grow earnings. Impressive cash generation with 70% of EBITDA getting converted to operating cashflow (OCF) and 90% of OCF converting into free cashflow.</li><li>High promoter stake (65.7%), consistent dividend policy and zero debt balance sheet are additional sweeteners.</li></ul>

A brand business on the urbanization theme- a very long runway. Brand strength illustrated by improving profitability and reduction in working capital cycle.South-India based electrical appliances maker with a portfolio of six successful products. None other than the market leader (Havells) has such a diversified portfolio.Large room to improve distribution in non-south geographies that contribute 33% of revenues now (9% in FY09). Non-south revenue per distributor is 1/4th of that of south-based distributor indicating large mining opportunity and better growth outlook.Business requires little capex to grow earnings. Impressive cash generation with 70% of EBITDA getting converted to operating cashflow (OCF) and 90% of OCF converting into free cashflow.High promoter stake (65.7%), consistent dividend policy and zero debt balance sheet are additional sweeteners.

India

V-Guard Industries Limited produces and manufacturers stabilizers, pumps, cables, fans, and electrical and solar water heaters.

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V-Guard Industries Ltd (VGRD IN)

India: AMFI Stock Categorization Changes to Drive Active Portfolio Churn

The reclassification of stocks to large, mid and small cap will set off a churn in mutual fund portfolios where historically stocks migrating...

Brian Freitas

India Consumer Electrical: Key Takeaways from 4QFY17 Results

Crompton chooses to defend margins while competitors chase growth Crompton claims it grew in line with end consumption; it claims competitors...

Bhaskar Chakraborty

V-Guard 4QFY17- Strong Growth, Lower Margins; GST Springs Negative Surprise

Grows 4QFY17 revenues 21.4% YoY on revival in post-demonetization demand in north India. Channel filling did not drive revenue growth unlike...

Bhaskar Chakraborty

Crompton Consumer or V-Guard: Which Do We Prefer

Crompton Consumer (CROMPTON IN) shares a number of business attributes with its smaller rival V-Guard (VGRD IN)- namely a long growth runway on...

Bhaskar Chakraborty

V-Guard: Multi Year Compounding Ahead

A brand business on the urbanization theme- a very long runway. Brand strength illustrated by improving profitability and reduction in working...

Bhaskar Chakraborty

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