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And then there were none….story of small and mid caps!

And then there were none....story of small and mid caps!

The weak sentiments on Dalal Street resulted in another day in the red. The weak sentiments are fuelled by numerous issues like liquidity crisis in the NBFC sector, demand slowdown in the auto sector & USFDA observations & lawsuits targeting pharma companies.

 

The issue liquidity in the NBFC space

The liquidity crisis which deteriorated the NBFC sector was triggered by a series of defaults by Infrastructure Leasing and Financial Services Ltd (IL&FS) in September 2018. The company deals in infrastructure development & financial services
As soon as the liquidity crisis was unfolded in the Non-banking Financial Service (NBFC) sector, numerous investors, mutual funds, Provident funds, banks, etc. resorted towards safeguarding their portfolios. Lenders initiated to limit their risk by reducing their exposure in these companies by over₹67,000 crores. Mutual funds have pared their exposures in NBFC’s like Edelweiss Group, Piramal Group, IIFL Holdings Ltd, Indiabulls Group and DHFL group.

The disintegration in the sector compelled multiple fund managers to write off their investments in NBFC’s amounting to around ₹3,000 crore.

 

However, mutual funds continue to have an immense exposure of ₹3.12 trillion in NBFC’s & housing finance companies. The funds have reduced their exposure to current levels from ₹3.79 trillion in September 2018. The liquidity collapse of 2018 has led to a transformation in investing strategies of mutual funds, Provident funds & AMC’s. Companies have adopted a cautious approach for lending to companies in the NBFC space. Due to the crisis funds have started to liquidate their positions by selling their loans rather rolling over their debt.

 

Is liquidity still a concern?

 

AMC’s have adopted an aggressive approach towards lowering their exposure in the NBFC segment. AMC’s attempt to shrink their exposure seems to be sentiment-driven as not all companies in the NBFC sector are undergoing a major crisis. Numerous NBFC’s possess healthy liquidity but unfavourable sentiment for the sector is resulting in severe swings in exposure patterns.

The negative sentiment is fueled by real estate exposure on the balance sheets of NBFC’s along with the uncertainty of refinancing.

During the same period, funds have raised their exposures in select companies in NBFC space. Companies like Bajaj Finance, Sundaram Finance Ltd, Muthoot Finance Ltd, HDB Financial Services and Kotak Mahindra Investments Ltd witnessed increased exposures. This signifies that funds are not dreary about the NBFC sector. The RBI introduced additional norms to regulate the NBFC sector which has given rays of hope to the investors.

 

Liquidity crisis enters new a new phase

 

The series of defaults by IL&FS has exposed the vulnerabilities of the sector and resulted in government intervention. The crisis in the sector has now entered into a new dimension. Other unstable financing companies like DHFL & Reliance Capital are struggling, risking the loans they were approved from numerous banks. Over the past year, DHFL has declined 89% whereas Reliance Capital has plunged over 83%.
Numerous defaults, further slippages in the books of banks from the NBFC space will continue to possess adverse effects on bank’s performances which are exposed to weaker companies in the NBFC sector.

Among major banks, Yes Bank seems to be the most vulnerable. The scrip has plummeted 65% in the past year amidst its lenient lending patterns. The stock has been put for a review for a downgrade by Moody’s amidst its exposure to weaker companies.

IndusInd Bank is another bank which was downgraded by UBS on account of its exposure of over ₹3000 crores in IL&FS and higher than expected credit costs. The stock has plunged over 26% over the past year and is currently trading at ₹1438.

 

Slowdown in the auto demand

Tata Motors has witnessed a 26% YoY drop in its domestic net sales in May 2019. The company sold 40,155 units in May compared to 54,290 units for the same period the previous year. The company also witnessed a 58% decline in its exports the previous month. The scrip has nearly lost half of its market capitalisation in the past year coming down at ₹158.95 as on June 20, 2019.

 

The market leader in the auto sector in India, Maruti Suzuki also witnessed a weak set of numbers for May 2019. The company saw a decline of 22% in its domestic net sales. The company sold 1,34,641 units in May 2019 in comparison to 1,72,512 units for a year on year basis. The exports of Maruti Suzuki dropped 2.4% on a monthly basis. The company is trading at ₹ 6,629.00 as on June 20, 2019, around 34% lower to its 52-week high of ₹ 9929.

 

Mahindra & Mahindra reported a 3% drop in its net sales for May 2019. The company sold 45,421 units versus 46,848 units for a year on year basis. The stock of Mahindra & Mahindra is down over 36% at ₹ 630.40 as on June 20, 2019, from its 52-week high of ₹993.

 

The slowdown in the sector is the result of higher financing costs coupled with liquidity constraints. The market for automobiles struggles amidst subdued consumer sentiments and muted market.

 

The Diesel Crisis

 

The newly announced safety regulations are adding to the ongoing diesel crisis. Introduction of BS-6 which regulates the output of air pollutants from vehicles has damaged vehicular portfolio of many car manufacturers.

 

BS refers to Bharat stage emission standards, These are the emission standards the Government of India sets to control air pollutants from internal combustion engines and Spark-ignition engines equipment, which includes motor vehicles

 

The cost of manufacturing vehicles compliant with BS-6 would be high which would result in declined demand for the cars.

 

New Safety norms & regulations by SIAM

 

Society of Indian Automobiles Manufacturers (SIAM) is the apex body responsible for regulating automobile manufacturing and safety measures in India. It has now become mandatory for vehicles having less than 9 seats to include the following features:-

1) Airbags
2) Reverse parking assistance
3) Seat-belt reminders
4) Speed warning systems

 

In addition to the above-mentioned measures, the vehicles are required to undergo a crash test. The crash test is a type of test where vehicles undergo through rigorous evaluation of safety systems and durability.

The newly implemented norms will escalate the cost of manufacturing and ultimately transfer the burden of increased prices to the customers.

The worries in the pharmaceuticals sector

 

Many Indian pharmaceuticals company have also been included in the US generic drug litigation. The companies were sued for co-conspiring with other drug companies to increase the prices of drugs. The generic drugs are of minimum price so that all competitors in the market can afford it. But some companies had a problem with this leading to an increase in prices of generic drugs in the US. Furthermore, against the price hike, 40 US states have filed litigation against 20 Pharmaceutical companies. Out of the 20 drug companies mentioned in this litigation include Aurobindo Pharma Lupin, Glenmark, Zydus, Wockhardt & Sun Pharma’s US arm Taro are amongst them.

 

Aurobindo Pharma

On May 17, 2019, the company informed the exchanges about three of its plants classified as Official Action Indicated (OAI). The US Food and Drug Administration (USFDA) has designated three of Aurobindo’s facilities as OAI after inspections. These three plants which are classified as OAI are Active Pharmaceutical Ingredient (API) facilities of Unit I and XI and intermediate facility of Unit XVI of Aurobindo Pharma Ltd.

 

Lupin

On May 14, 2019, Lupin disclosed that it received four observations in the establishment inspection report (EIR) given by USFDA following the end of its inspection of pharmaceuticals issue.

The inspection involved complex scrutiny of procedures & practices for reporting side effects of the company’s products marketed around the world. The inspection was concluded with four observations.

The company received the EIR from the USFDA for the post-marketing adverse drug experience (PADE) inspection, indicating successful closure of the inspection.

 

Cipla

 

Mumbai headquartered Cipla received eight observations on eight good manufacturing practices (GMP) from USFDA for its factory located in Kurkumbh, Maharashtra.

In addition, the company received 10 observations related to a product-specific pre-approval (PAI) from Kurkumbh.

In addition to the numerous observations received by Indian pharmaceutical companies by the USFDA, the domestic growth of the sector is also stagnated. Multiple lawsuits faced by pharma companies for manipulating prices of drugs has adversely affected on their margins.

 

Due to these multiple factors, the market has been under pressure. This has caused investors to adopt a cautious approach while investing.

 

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