Wealth Creation from Sectoral Trends

The Asian Development Bank predicts that the Indian economy will expand by 7.5% in FY2022 and by roughly 8% in FY2023, supported by rising public infrastructure expenditure and a rise in private sector investment. Investors are prepared to devote a larger percentage of their savings to capital instruments in 2022 and are also motivated to invest in the growing industries in India. They are also inspired to invest in India's expanding industries. This blog will cover those sectors that will grow in the future in India and sectors that will flourish even more in the investing game, in the near future. Along with that sectoral Growth triggers and their impact, sectorial past performance is discussed.

05 Sep 2022
Wealth Creation from Sectoral Trends

For long-term investments, it makes sense for a wise investor to put money into India's expanding industries. However, there is a key lesson to be drawn from this: not every expanding industry will offer great returns. Diversification is the best strategy for choosing the best investing industries in India. Allocate funds to various sectors that you believe will grow, reducing risk. Based on this concept, PMS Bazaar conducted a webinar “Wealth Creations from Sectoral Trends”. The keynote speaker was Mr. Amit Doshi, Co-Founder & Investment Director, of Care Portfolio Managers.

Mr. Amit made a detailed analysis of some of the key sectors and also explained the sectoral growth triggers and their impact. He also illustrated the past performance of these sectors with respect to their benchmark.

Some of the key insights of this webinar are:

  • Sectoral performance versus the index.
  • Sector triggers and their impact

Sectoral Performance Versus the Index:

The above data represents the performance of the index versus various sectors over a period of 2019-2022. In that, it can be seen that some of the sectors had outperformed the index and some sectors generated higher returns than the NIFTY index. During the year 2020, which was the Covid-19 pandemic year, sectors such as pharma outperformed the NIFTY index. In 2021, defense and real estate also performed very well irrespective of the index not performing greatly. Hence, it can be concluded that irrespective of the index performance, if an investor can identify which sectors are likely to do well, they can invest in those sectors and hence generate higher returns.

Past performance – Sectoral triggers and their impact

1. Pharmaceutical sector (2012-2016)

Several triggers led to the rally in the pharma sector during 2012-2016. The first trigger was the introduction of GDUFAby USFDA. Generic Drug User Fee Amendment or Generic Drug User Fee Act (GDUFA) is a law enacted by the United States of America (USA) under the Food and Drug Administration Safety and Innovation Act (FDASIA) to speed the access to safe and effective generic drugs to the public and reduce the overall cost to the industry. The next trigger was that the rate of new drug approvals (ANDA approvals) increased drastically over time. Review that used to take as much as 26 months was reduced to 14 months. During the same period, many drugs that were patented went off patent, making it easier for the Indian pharma sector to manufacture.


The next trigger was the expansion of the US generic market share from 72% to 90%. With the introduction of GDUFA, several proactive Indian pharma companies leveraged the opportunity and in 2011, there were 17 new generic launches by Indian pharma companies. This increased to 28 in the year 2015. Also, the size of the market share increased to 70 billion dollars. 

Impact:

To ensure that they continue to generate and launch this generic business from the United States, a lot of Indian companies spend a lot of money on research and development during that phase. On average, they increased their annual research and development spending by 33 percent.

They increased their sales contribution from an average of 28 percent in FY 11 to 40 percent in FY 15. The revenue CAGR was significantly up on average by 26 percent, and the average operating profit increased by 28 percent of CAGR> this is because these companies took steps to increase their US contribution, which increased in both their top and bottom lines.


2. Specialty Chemicals (2016-2022)

China grew by leaps and bounds after 2009 significantly and they made heavy production manufacturing without considering environmental norms. However, in 2016 they became conscious and a lot of environmental norms were stringently followed. Nevertheless, it was quite late, and there was a huge impact on the Chinese chemical sector and 40% of the capacity had to shut down. Secondly, there was a significant disruption in the Chinese chemical market due to the US-China trade war. 15 percent of China’s export to the US got impacted during that time.


The cost of labor and power also increased significantly, and because of the strict environmental regulations, the cost of compliance also increased significantly. As a result, the previously very competitive Chinese began losing ground in the worldwide market. Now, throughout the same period, India enjoyed good environmental conditions. Many reputable companies invested extensively in the zero liquid discharge system so they could be fully compliant with environmental regulations and be the ones to take advantage of the opportunity that arose from the environmental disruption in the Chinese chemical market.

The cost arbitrage sourcing paradigm was replaced with knowledge arbitrage-based strategic alliances. However, global companies wanted to move down to more knowledge-based arbitrage-based arbitrage and have strategic partnerships. Hence, India started spending a lot of money on R&D during that phase so that it could enter into strategic partnerships with a lot of foreign global companies. 

Impact:


Indian chemical companies anticipated the trend and made significant investments. The results can be seen in the form of strong CAGR growth of 16 percent and these companies were valued at 15-16 times their average multiple, or significantly jumped to 23 times their pre-investment value.


3. Sugar Sector (2018-2022)

All sugar mills were experiencing losses due to the extremely high cost of production at the time. As a result, many businesses fell into a situation where their working capital was severely restricted, preventing them from turning a profit. As a result, they were forced to delay paying sugar cane farmers. This is when the government intervened, realizing that there was a problem and that action was necessary.

So the government introduced MSP (minimum support price) for sugar. While sugarcane was always under MSP for farmers, for companies it was not the case. With the introduction of MSP companies that were making losses earned profit and they in turn were able to pay farmers. So MSP impacted the sugar industry positively.


However, there was massive overproduction of sugar in 2017–18. Hence, the government had to introduce export subsidies to release this excess inventory. By introducing export subsidies sugar manufacturers were able to reduce the excess inventory and free up working capital for the business. The export subsidy was introduced to encourage the export of goods and discourage the sale of goods on the domestic market through direct payments, low-cost loans, tax relief for exporters, or government-financed international advertising.

The next trigger was ethanol blending. Ethanol is an agro-based product, mainly produced from a by-product of the sugar industry, namely molasses. In years of surplus production of sugarcane, when prices are depressed, the sugar industry is unable to make timely payments of cane prices to farmers. The Ethanol Blending Programme (EBP) seeks to achieve the blending of Ethanol with motor spirit to reduce pollution, conserve foreign exchange and increase value addition in the sugar industry enabling them to clear cane price arrears of farmers.

The ethanol blending program gave a lot of financial consistency to the sugar manufacturers and they could see a change in their revenue and profits. Today, ethanol blending is at 1.5 to 2 percent and the target of the government is to make it to 20 percent. The consistency in the numbers and profitability of the ethanol were both there because the ethanol prices were linked to the sugar cane prices. So any rise in the MSP of sugarcane was passed on to the ethanol producers as well. That could easily be translated into better profits from sugar prices. Hence, the sugar price remained firm last few years. 

Impact:


The fundamental changes that affected sugar companies in the industry profitability of 330 crores increased to 2000 crores in four years. The loan portfolio of most companies decreased due to reduced inventory and free working capital. Similarly, short-term loans also decreased during this phase, which resulted in a significant increase in profitability and cash flow generation.


Identification of Triggers for the Above Sectors                                                                  

Factors to look for when identifying triggers for the above sectors are -

  • Geopolitical happenings
  • Government policies
  • World economy 
  • Global and local initiatives taken related to the above sectors
  • Monetary Policies
  • Inflation rates
  • Whether climatic conditions
  • Employment data
  • Exchange rates
  • Commodities price trends

Classification of Triggers

(1) Long term - 

  • Trade pacts/trade barriers
  • Government policies
  • Change in global factors, post- Covid, China+1, etc
  • Zero carbon emission

(2) Short-term - 

  • Easy money policy
  • Inflation/interest rates
  • Changes in commodity prices
  • Bounce back to the industry

How to participate? Consider the below -

Macro factors - 

  • Industry size
  • Growth rate
  • Demand-supply scenario
  • RM availability

Micro factors - 

  • Valuations
  • Management
  • Financials
  • Market share
  • Company size

4. Paper sector

The year 2018 saw a significant import from nations such as Thailand and Vietnam they are extremely inexpensive in comparison to domestic paper company manufacturers. Other than India, these countries have a policy for forestation where paper manufacturing companies would own a proportion of the forest where they source raw materials. However, in India, there is no such policy. Considering dumping by nations, the government introduced anti-dumping duty which in turn prevented dumping by other nations.


The next trigger was the prohibition of single-use plastic The environment plays a significant role, hence, in 2020, the government announced that they would stop using plastic products. The third trigger was the China Factor: In 2021, China banned waste paper and due to environmental concerns, hence waste paper was no more imported. After Covid, there was a demand for packaging, hence the demand for paper too increased. The other factors are the implementation of BIS standards to restrict low import quality.

Impact:

With 18% of the global population, India is the fifth-largest consumer in the world despite only consuming 4.2% of the world's total consumption. This shows how the global paper industry is structured and how India fits into it. In India, the majority of the market is an extremely unorganized segment (SMEs), accounting for almost 85% of sales. 


These SMEs are distributed throughout the nation and are not well organized in any way. By 2027 the industry growth will increase from the present 18 to 19 million tonnes to 23 million tonnes. Therefore there is a chance that this industry may continue to expand successfully in the future.

5. Auto Sector

One main trigger is the festive season. After two years, we should witness a thriving festive period, and all automakers have positive management commentary regarding growth in that market segment. In addition, credit availability hasn't decreased significantly, so they should be able to increase credit availability through increased demand for automobiles. Overall, new cars are being introduced. There was a huge waiting period due to the Covid-19 disruption; however, with the majority of these issues now resolved, we can hope that this impact will turn out to be positive and will be reflected in the increase in numbers in the automobile sector. The commodity price, which was the negative trigger, is now again with declining commodity prices and growth peaked out and probably settled at lower levels likely to act in favor of the automotive sector. 


Impact:

How do you play or participate effectively? We believe that the automobile industry is becoming slightly more competitive as a result of the entry of this new global player, so it's likely auto ancillary is a shadow play that can also be played or invested to generate similar types of returns in this automobile advantage. Because of the possibility of intense competition, it may be difficult to determine which company will succeed.


There are several reasons why we think this auto engineering will thrive. This is because of a significant investment of almost 26 000 crores, one of the largest allocations for the PLI scheme of an auto ancillary. There is also resilience because, while OEM (original equipment manufacturer) did poorly, auto ancillary still performed well, so there is a small amount of resilience in that sector, making it safer for original equipment manufacturers (OEMs) who had a difficult time, but there was a secondary aftermarket potential and an export opportunity that persisted for the auto ancillary companies.


6. Defense Sector

A vigorous drive by the government to involve the private sector is one of the key triggers. The government has stated that without private sector participation, India cannot become a strong indigenous player in the defense segment. The government has a very ambitious target of 1.7 lakh crore by 2025, which indicates that this industry will likely grow by about 15% over the next three to five years.


There has been a significant increase in the government's budget for defense spending of almost 11 to 12 percent. In addition to the expenditure on the outlay, they also announced a CAPEX of almost 1.5 lakh, which is again 10 to 12 percent higher than last year's budget. Accordingly, there has been an increase in the government's allocation for that space, uh, FDI participation. The government now permits 100% FDI, of course, with a 74 percent automatic group, but for more than 74%, a clearance procedure will be required. However, international players are permitted to enter and establish manufacturing in India. Exports are prioritized, therefore from 2014 to 2022, sales increased from 2000 crores to 12,000 crores, which was roughly six times.


Mr. Amit discussed all the above topics in detail. Towards the end, Mr. Amit answered questions from the audience, touching upon topics like – Effect of digitization on the paper Industry, the outlook on the IT Sector, the One nation One Fertilizer policy, the Defense sector, and much more. For more insights on this webinar, please click the appended link

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