Portfolio Review – 4Q FY24

Reviewing Q4 FY24 at Itus (Mar 24 Earnings Quarter)

We had ended FY24 (March 2024) earnings season, with a robust earnings growth translating into a stronger Cash flow growth in our portfolio companies. One of the characteristics that defined the portfolio was operating leverage playing out in the next cycle, as the capex our portfolio companies was deploying on the ground, was funded through internal accruals and the demand cycle being strong, meant that the cash conversion cycle was lower than the 10Y average we had seen.

We had anticipated FY24 to be a year of a relatively muted (lower than prior year) topline growth, offset by better Cash flow growth. While the topline growth was in line with our expectation, the growth in earnings was materially better than our expectation and modelling.

The quarter went by (Mar 24 – Q4FY24) saw strong annual growth in revenue and profitability across our portfolio. While QoQ growth is seasonality driven, on a YoY basis, our profitability margins grew along with robust revenue growth. There were a few interesting trends in our portfolio companies which we highlight in further detail below:

Note: For the year-on-year (YoY) measurements, we have taken a rolling 4 quarter format, i.e., Q4FY23 to Q4FY24, as compared to Q4FY22 to Q4FY23. This helps us track growth of our portfolio better, removing dependence on cyclicality in the quarter. Our portfolio companies continue to demonstrate healthy growth and profitability.

We also measure the health of the portfolio with the following metrics, that give us a summary of the earning capability of our holdings.

As we have mentioned in prior quarterly notes, our portfolio is overweight capital goods, power, auto with a 2W focus and rural consumption. We continue to see tailwinds for growth and will monitor the trends on the ground for additional channel-checks to re-validate our thesis and translate this into our positioning.

Below we highlight a few key themes worth monitoring:

Auto & Auto components – Two wheelers 

As highlighted in our previous note that while the 2W volumes over the last decade has moderated and just seen 2.4% CAGR growth, the 2W demand shifted from sub-125cc motorcycles to scooters and premium 125cc+ bikes over FY13-18. However, this trend reversed over FY19-22, as the rural economy held up better than urban for 2W, while the replacement cycle, in our view, got delayed amid Covid.

Two-wheelers (2Ws) have lagged in recovery but the abnormal 35% fall over FY19-22 created a very favourable base for the segment that is core to personal mobility; we believe 2Ws are ripe for a replacement cycle too. The domestic registrations for 2W’s in the country have grown at over 10% over last three quarters YoY. The export units for the OEM’s have also been seeing strong enquiry and strong outflows. With rural pickup, we expect the 2W’s volumes to sustain and our investments in two-wheeler OEM (Bajaj Auto, TVS & Eicher) & related ancillary (Suprajit Engineering) are an extension of the same.

Exhibit 1: Domestic Two-wheeler registrations (source: VAHAN)

Rural Recovery: 

The pandemic impacted consumption and we have witnessed sluggish consumer demand since then, this has specifically impacted the mass consumption categories like FMCG and companies providing entry level products like entry level 2W and 4W. Consumption in this segment has been hit due to two factors – Income growth trailing inflation rate post COVID and pressure of various EMIs that these consumers have to meet. As a result, the first-time buyer for entry/mass products is missing from the market and this has also impacted the rural markets.

We are now however seeing uptick in rural demand, this is seen on the back off strong 2W sales, a proxy for rural demand as 50% of 2W sales comes from rural India. Commentary from FMCG companies also point out to uptick in rural demand.

Exhibit 2: Excerpt from Dabur, Q4FY24 concall

Exhibit 3: Excerpt from Hero Motocorp, Q4FY24 Concall

Factors that could help in sustaining this recovery are discussed below:

Agri Income constitutes 32% of rural income and current developments like – improved yield, increase in MSP by 6-10% and reduced input prices will lead to increase in farm income. This will help in rural spends.

On the other hand, growth in non-farm income is critical for rural demand. On this front, we do see that the work demanded under MGNREGA has fallen.

Exhibit 4: Work demanded under MNREGA

One of the factors causing the fall in the work demanded MGNREGA is the free food scheme that the government is currently running. Under this scheme a family of 5 gets 25kg of grains every month, sufficient to feed the family. MGNREGA job demand needs to be closely watched as it is one of the proxies for tracking non-farm income. Higher demand will lead to more money in the hands of the final consumer which will lead to higher discretionary spends.

Factors that could help boost non-farm income and that need to be watched are Government spend on rural and agri segments, it is estimated that Rs 10 trillion is to be spent on these segments as compared to Rs 9.8 trillion in FY24. Higher allocation to social benefit schemes like PMAY and Krishi Sinchai Yojna should also help. The upcoming budget needs to be watched closely on what the government does on these fronts.

As far as the sectors that are currently showing strength are 2W, domestic sales in FY24 stood at 18 million units as compared to 15.9 million units in the previous year. Commentary from FMCG companies on revival of rural demand is positive and volumes of leading plastic pipe companies catering to the agri segment have been shown double digit volume growth at the end of FY24.

Green shoots are visible in rural recovery. Monsoons, rural inflation, government’s approach to the rural economy will hold the key for the segment going forward.  We had invested in the rural recovery theme across multiple sectors in the portfolio and will continue to monitor the trends and growth in the sector.

Why we remain underweight on Banks:

Banks form the largest sectoral exposure in the benchmark – Nifty, we at Itus, remain underweight in this segment.

Even while the Deposit growth for banks, both public and privately-run, appear to be robust, it is crucial that we examine the data to obtain a more comprehensive picture in conjunction with our macro-outlook. CASA Deposits have increased at a substantially slower rate than total deposits over the past 1.5 years; the expansion has been driven by term deposits, which suggests that the cost of capital for these banks would be incrementally higher – and should lead to a decline in Net Interest Margin (NIMs).

Exhibit 5: CASA growth underpaces Deposit growth significantly

Furthermore, while banks’ advances growth has ranged between 14 and 20% CAGR over the last two years, most banks have seen their operational expenditure growth average more than 25%. This should negatively impact their Return on Assets (ROA).

Exhibit 6: Operating Expenditure growth for top banks has averaged >20%

Another factor that might compound banks’ woes is if the Reserve Bank decides to lower interest rates, which could have an impact on deposit growth and, eventually, ROAs. At Itus, we choose to be selective in the banks we add to our portfolio, where we see pockets of loan growth and yield pass-throughs.

To summarise, the below table gives an overview of the health of our portfolio as of Q4FY24 (with the snapshot as of May 2024):

Note: The sum of above weights would not total up to 100%; remaining would be our cash holdings.

Team Itus

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