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Reviewing Q3 FY23 at Itus (Dec 22 Earnings Quarter)

The quarter went by saw strong annual growth in revenue and profitability across our portfolio. 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., Q3FY22 to Q3FY23, as compared to Q3FY21 to Q3FY22. This helps us track growth of our portfolio better, removing dependence on cyclicality in the quarter.

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

Portfolio Metrics1

In our communication this quarter, we were keen to highlight a few themes that we have exposure to –

Today, the 3 sectors that contribute to 60% of the market weights of Nifty include Financials, IT and Auto. Its important to look at the earnings growth of the 3 sectors mentioned to have a view on the sustainability of the earnings and growth of the index, which in turn has implications for the market.

Financials (Lending)- Robust growth but headwinds seen?

The three largest private banks – HDFC Bank, ICICI Bank & Axis Bank have all seen an increasing net interest income over the last four quarters coupled with healthy growth in advances and deposits.

While we have seen Net Interest Income growth, we believe in a higher interest rate environment, the advances growth would be slower than what we have seen in the last 2.5 years, leading us a cautious view on investments in banks. Private sector banks continue to be aggressive on garnering deposits alongside increasing the rates on CASA. While, this is an extremely healthy trend in the medium term, this should put a ceiling to the growth of NIMs in the near term. We continue to be underweight banks today in comparison to the indices, and would look to be selective in adding risk in selective names at the right valuation.

PortfolioMetrics2_3QFY2023Fig: Net Interest Income of HDFC, ICICI and Axis bank 


PortfolioMetrics2 3QFY2023 1

Fig: Advances of HDFC, ICICI and Axis bank

PortfolioMetrics2_3QFY2023Fig: Deposits of HDFC, ICICI & Axis bank


IT – Mixed Signals

While the three largest IT players in the country have continued to show revenue growth over the last 7 quarters it is worth noting that their additions of employees have steeped off since the beginning of FY23 and its amongst the lowest in the last seven quarters.

If we step back a bit, the expectations for the sector was for companies to have a slowdown in order book which in turn implied a weaker revenue growth expectation. However, looking at the earnings and the margins trajectory in the last 2 quarters, majority of the companies in IT have shown much better topline and bottomline growth numbers.

However, at a time when the companies have been reporting consistent deal wins and a robust increase in order book (to the surprise of many), cutting down on its most valuable resource – employees, is not a great sign and gives mixed signals in the current macro environment. This is one of the reasons we have not gone overweight in the sector yet in our portfolio.

image1Fig: Quarterly revenues of Infosys, TCS & HCL Tech


image2Fig: EBITDA Margins of Infosys. TCS & HCL Tech


image3Fig: Net Addition of employees in Infosys, TCS & HCL Tech


Auto Sector Growth – Looking at Registrations:

The 4-wheeler registrations in India have reached the pre-covid levels (2018-19) largely led by the passenger cars. It is worth noting that 2-wheelers registrations have seen a drop of nearly 5.7% as against Feb’2018.

Given the cyclicality in the demand cycle, we prefer to look at Auto-ancillary companies where the companies have a sticky B2B relationship with the end-clients and can protect/pass on margins (depending on the value-addition they provide in the supply chain).                                                               

4W Registrations 1Fig: Four Wheelers Registration in country over last 5 years


2W Registrations

Fig: Two Wheelers Registration in country over last 5 years


Company Updates:

Each quarter, we talk about 5 companies that have had meaningful business updates during the quarter, highlighting our take and our thesis for our holding.

Indoco Remedies:

Indoco Remedies is a generic pharmaceutical manufacturer and marketer of Formulations (Finished Dosage Forms) and Active Pharmaceutical Ingredients (APIs) in India and globally. They operate 9 manufacturing facilities, out of which, 6 are for finished dosages and 3 for APIs.

Our investment thesis in Indoco broadly can be divided into two:

  1. Export Formulations: During FY17-20, Indoco went through a period of pain with regulatory issues pertaining to the USFDA, which led to the US share of exports falling from 46% to 25%. In the last 2.5 years, several of their export-focused plants have received inspections, along with the launch of new drugs that led to a 26% growth from this segment in FY22. Currently, their US business has not reached profitability w.r.t investment, which should improve once plant gets required approvals. (They are in the inspection stage for their Goa plant, ~1500cr generation capacity in Oral Solids and Ophthalmic).
  1. Domestic Formulations: Indoco’s growth from India formulations has typically been 7-8% CAGR. A significant portion of the company’s finished dosage formulations drugs, are positioned #1 or #2 in India with Indoco having a dominant share – and over the last year, Indoco has added a layer of middle management, in an effort to improve sales efficiency.

image5Fig: Revenue growth and breakup of Indoco Remedies

Anti-Infectives & Respiratory saw a 6% and 1% degrowth in Q3 YoY, while the rest of portfolio grew 16% on the same period. Pre-covid, these 2 segments contribution was at ~30%, and at the peak of covid, contributed 36-38%. In 9MFY23, the contribution was 29.6%. Given we have seen normalization, we expect growth to come through in overall domestic sales henceforth.

We see growth coming from Export formulations growing at 17% CAGR (driven by revival in US business) and Domestic at a 7% CAGR (based on historical performance) in the base scenario, reaching a 2,100cr turnover by FY25. This should result in a 20% IRR from our buying limit.


HDFC Life Insurance:

HDFC Life Insurance Company is engaged in underwriting and selling Life Insurance in India. It is the third largest company by Annualised Premium Equivalent after LIC and SBI Life Insurance.

Image 6

Fig: APE Mix of HDFC Life Insurance (9MFY23)

The VNB margins of the company have steadily grown over the last several years (VNB Margin for 9MFY23 (post-merger), despite lower margin of Exide Life; VNB margin was 22.6% in FY17). This has been done by improving product mix (reducing ULIP; increasing non-Par).

Among Life Insurers, our thesis on HDFC Life rested on its best-in-class positioning on a few key metrics such as APE Mix (leading to higher VNB Margins), highest Persistency Ratios, reliable distribution channels and growth in APE market share (outpacing Industry).

    Image 7    Image 8

Fig: APE and VNB growth for HDFC Life Insurance

During Budget 2023, the New Tax Regime announced would add tax upon redemption of Life Insurance policies with cumulative premiums of >5L, first year premiums exempt. We believe the impact of this would be limited towards non-Participating guaranteed return products being disincentivized (roughly 30% of HDFC Life’s APE mix)

While overall premium growth may be slower in the next 2 years, we believe HDFC Life has one of the most reliable distribution channels among life insurers and is best poised to benefit from capturing a larger share of incremental market.


HDFC Bank:

HDFC Bank Limited is India’s largest private sector bank by assets.

Our comfort and thesis on HDFC Bank rests on a few factors:

  1. Consistent loan growth: Very rare to see a bank (even globally and especially in India)grow consistently >20% each year without overt cyclicality.
  2. Lending NPAs are the lowest among private banks consistently (led by a culture in lending with right processes). This has helped them avoid large Non-Performing Assets while peers have had issues.

image9      image10

Fig: Advances and Deposits growth for HDFC Bank

Advances and Deposits grew 19.5% and 19.9% respectively in Q3FY23 over Q3FY22. (Deposits grew faster than other private banks which were in the range of 10-14%). Loan (Advances) growth driven by Commercial & Rural Banking (+30.2%) and Corporate loans (+20.3%). Retail loans also grew (+21.4%).

image11    image12

Fig: Comparative Deposits and Advances growth for banks in India

Currently, the bank trades at ~3.5x P/B at Book Value of ~485/share as of Q3FY23. Assuming that we see no further market re-rating, a 42% upside by FY25; potential IRR: 17% (Current Market Cap: 9.31 lakh Cr).


RHI Magnesita:

RHI Magnesita (RHIM) is engaged in manufacturing and trading of refractory products, which are indispensable for industrial high-temperature processes exceeding 1,200°C in a wide range of industries including steel, cement, non-ferrous metals and glass. Currently more than 70% of the demand for refractory products comes from the steel industry (for 1 ton of steel 10 kgs-12 kgs of refractories is used). Hence, growth of the refractory industry is linked with the steel industry. But despite the dependency refractory companies don’t show qualities of a commodity company as their gross margins do not get affected as they are able to pass on the fluctuation of raw material cost, which represents the pricing power for such a sector.  Also, the replacement cycle for refractories depends on industry to industry but specific to steel it is around 2weeks- 1.5 months, hence it removes variability of cyclicality in the earnings.

image13Fig: RHIM revenues & EBITDA Margins (*The yellow bars represent the standalone numbers of Orient Refractories)



Fig: Revenue estimates of RHIM post acquisitions of Hi-tech & Dalmia refractory


Over the last quarter, the company acquired two companies namely, “Hi-Tech Refractories” and “Dalmia Refractories” following which the company’s market share in the Indian refractory space goes to over 30%. The acquisitions strengthen the company’s product line in the industrials segment in which it was earlier under presented.  Now the combined capacity of the company stands at 5lk TPA, of which 1.5 LTPA remains unutilized capacity ready to serve the additional requirements of the Indian market. The government has announced a steel capacity target of 300 million tones. It had also announced an enhanced capex of Rs 10 lakh crore in the Union Budget. All this augurs well for the industry, where increased infra spend will increase the demand for products manufactured by our consumer industries.


Balkrishna Industries:

Balkrishna Industries Limited, commonly known as BKT, is an Indian multinational company that manufactures off-highway tires for vehicles such as agricultural tractors, construction equipment, mining machinery, and industrial vehicles.  BKT has a wide distribution network that spans over 160 countries, which gives it access to a large and diverse customer base. BKT has been steadily growing its market share over the years, thanks to its focus on innovation, quality, and customer service.

image15          image16

                    Fig: BKT’S Volumes and Realisations                                         Fig: BKT’S Revenue profile coupled with EBITDA Margins


While the 9MFY23 revenue is up 26% against 9MFY22, its profitability has taken a hit and was down 25% during the same period against 9MFY22. Being a export dependent company majorly, the company’s margins were hit in the first two quarters of the fiscal year due to increased costs of raw materials and higher logistics costs. Subsequently, the company was also impacted due to channel de-stocking and high-cost RM inventory in the system in the reported quarter. The channel de-stocking is expected in 4QFY23 too, though at lower intensity than 3Q. Also, the logistics costs and rubber costs are now reverting to pre-covid levels, which should help in recovery of margins in the coming quarters. The management has invested over~INR30b in last three years towards expanding capacity in tyres as well as carbon black coupled with modernization and automation. On completion of the ongoing capex, its capacity would increase to 360 MTPA by 1HFY24; hence capex intensity should moderate leading to higher free cash flow.  We expect BKT’s outperformance to the industry to continue, with scope to strengthen its competitive positioning.


Investment Changes

This past quarter we made a few changes to our investments. We shall highlight our reasoning and thesis for our decisions.

Fine Organics (Sell):

Fine Organics manufactures specialty chemicals focussed on food additives and polymer additives, operating in a space where there is little competition domestically. The management had scaled its capex in 2020, post which we decided to start an allocation to the business.

The company’s products are a small percentage of the cost for the end-industry, yet essential (reflected in its cash conversion cycle consistently at <80 days) and is used predominantly in the food industry – across bakery, biscuits, chocolates etc. Our weighted average IRR on the investment was at 69.1% across all clients and the weighted average holding period was 1.8 years. Through our holding period, Fine Organics grew its topline and cash flows at a compounded growth of 27.5%.


Fig: Fine Organics Revenue Growth


One of the reasons for this high growth of the business came from the quick time the business was able to sweat its capex. The demand cycle for its product continues to be robust and the execution by the management was one of the best. We expect Fine Organics to continue to grow at a 20% growth rate in an optimistic environment. While the demand cycle for the product (the additives they manufacture) seems robust, we believe the valuations for a B2B business reflected the optimism.

We have been prudent to completely exited our position in Fine Organics across all clients in the fund. The exit was completed in October of 2022.

Infosys (Sell):

Infosys is an Indian multinational information technology and consulting company that provides software development, maintenance, and independent validation services to businesses worldwide. We had first started buying Infosys towards the end of 2017 when there were issues around the board and the previous CEO of the company. We have continued to selectively buy the company well into 2020 post Covid. Our weighted average IRR on the investment was at 31.2% across all clients and the weighted average holding period was 3.1 years.

image18Fig: Net addition of employees in Infosys

Through our holding period, Infosys grew its top line and cash flows at a compounded growth of 18.2%. Over the same period, the investment gave us an IRR of 31.2% (weighed average). Infosys continues to have its growth closely linked to the IT spends from a global perspective. With the rising interest rates and moderation in the addition of employees. IT sector is known for being highly competitive, and companies may have to react quickly to changing market conditions. As a result, they adjust their workforce relatively quickly based on changes in demand or market conditions, and slowdown in net additions indicates the caution amongst the company.

We expect Infosys to continue to grow at a 15-16% growth rate in an optimistic environment. Today, there continue to be risks to the growth rate the management is guiding for and we believe it is prudent to exit the investment at the realized return generated.


To summarise, the below table gives an overview of the health of our portfolio as of Q3FY23 (with the snapshot as of December 2022).


* Companies exited during Q3FY23

Team Itus



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