There is no doubt that the events of the past couple of weeks has left investors in a state of confusion, unease and uncertainty. IL&FS was the first such news flow that rocked the markets. We published a note titled “When fixed income rocks equity markets” soon after the IL&FS issues surfaced. In this note we had spelt out areas that investors need to focus on rather than paying heed to the news that seemed to suggest that India is going through her Lehman moment. We thank our investors for their encouraging comments on the views expressed and the process adopted by Phundo in managing risks.

Last week, another significant impact grabbed headlines.

The Finance Minister on Thursday 04 October 2018 announced Rs 2.50/litre reduction in fuel prices of petrol and diesel. Normally, markets were not expected to react so adversely by this announcement. As the FM elaborated on this reduction, markets went into a free fall on hearing that the Oil Marketing Companies (OMCs) would bear a reduction of Rs 1/litre with the rest being borne by the central government exchequer.

We have heard of the phrase “data is the new oil” that pertains to the Indian telecom sector. Reliance Jio’s strategy could have been one of the causes for incumbent operators’ “losses”. This time the word going around town is “old wine in new bottle” referring to the government’s decision to roll back the deregulation policy of “minimum government, maximum governance”.

Has the FM sounded the death knell for the Public Sector Disinvestment plan? Will he silently build a new strategy to instil investor confidence? Lots of questions need answers but for now the opinion both national and international seem to suggest: -

1. The government has rolled backoil reforms.
2. Accentuated further on overhang of future rollback if oil prices increase.
3. No imagination and innovation in the government’s strategy to counter the increase in oil prices.

Just as stated in our note on IL&FS, Phundo believed that the government will act quickly to arrest any future downward spiral of the economy and the markets. They did just that and within a short time dismissed the existing board members and brought in the “A” team headed by Uday Kotak (Promoter & Head of Kotak Mahindra Bank).

We don’t doubt that similar action will now be taken in respect to bringing back the confidence that the government is indeed serious on reforming the Public Sector Units.They have repeatedly stated that disinvesting its stake to make these giant enterprises more efficient and productive is in the national interest.

The first step to reassure the market has been taken.

The next steps of putting these words into action will follow in the days to come. But let’s get to the point of separating fact from fiction.

Oil is a complex business. We shall try our best to deconstruct this to help in a better understanding of this industry, which we hope will help investors make an informed decision. After all, oil touches our lives on a daily basis and any fluctuations to this essential commodity will impact our financial decision making.

Oil Marketing Companies also known as “downstream” companies live of the refining margins. They invest in complex refining infrastructure that can process various blends of crude oil that they import. Hindustan Petroleum Corporation Limited (HPCL), Indian Oil Corporation (IOC), Bharat Petroleum Corporation Limited (BPCL) are downstream oil companies supplying petrol and diesel to two, three- and four-wheel owners through petrol pump outlets.

Indian Oil Producers are “upstream” companies that are involved in oil exploration and extraction. These companies are issued licences by the government to discover oil covering several thousands of kilometres. Upstream companies invest in seismic studies which help discover hydrocarbons below land surface based on which, they use complex materials, processes and equipment to test the potential of the wells. Both upstream and downstream companiesare dominantly owned by the government given their strategic national interest. The two largest upstream companies in India are Oil and Natural Gas Corporation (ONGC) and Oil India Limited (OIL).

The announcement by the FM on Thursday 04 October 2018, clearly stated that the Rs 1/litre subsidy will be borne by the Oil Marketing Companies (downstream companies). While the shares of HPCL, BPCL & IOC fell by more than 20% on account of this announcement, ONGC &OIL were not spared. In excess of over Rs 1 lakh crores of market capitalization was wiped out across the industry.The profitability by this measure is likely to erode by over 20% for the downstream companies.

Has the stock market over reacted? Does fear psychosis provide us an opportunity?

"Let me categorically assure all that there is no going back on deregulation of oil prices,"

India's finance minister Arun Jaitley said in a Facebook post on Saturday 06 October 2018.

Given this, Phundo analyses the options that the FM could employ to demonstrate that India stands firm behind reforms: -

1. The intent of the Government is to bring oil under GST. However, this is easier said than done. Delaying this allows for windfall gains for both state and central governments. Economically, its possible but politically this will be challenging to implement.
2. His statement of 04 October 2018 has created significant uncertainty on India’s privatization program. Therefore, one will expect an even more accelerated path of execution to build back the confidence of global investors.
3. The most significant move that we would expect the government to make is its dividend paying policy. Currently, profit making PSUs are expected to pay out a minimum percentage of their post-tax profits as dividend which comes from sizeable revenue receipt.
4. As far as upstream oil companies are concerned, 2019 could be an all-time record year of profit achievement due to higher crude prices and a depreciating rupee. Assuming that OIL makes anywhere between Rs 3,500crs to Rs 4,500crs and ONGC Rs 25,000crs to Rs 30,000crs profits for FY 2018-19, companies could pay a special dividend of 70% which would net Rs 20,000crs to the exchequer.
5. Finally, if the government cushions the increasein oil prices by reducing the excise tax, then we believe that a rollback of the subsidy on the downstream companies will be imminent given the serious erosion of market-cap of these companies and inconsistency in policy (both disastrous for any disinvestment program). Instead, Phundo is of the view that higher dividend pay-outs by profitable PSUs will help cover any shortfall in indirect tax collections and maintain a healthy current account deficit. Dividend income forms a significant portion of revenue receipts for the government.

Any move in the direction as highlighted above would benefit minority shareholders. Needless to mention, markets are driven by sentiments and such indicators will increase the confidence.

In conclusion Phundo strongly recommends the following: -

1. Diversification – this will ensure investors invest for maximum total real return on their portfolio.
2. Invest – don’t trade or speculate. Investing allows for unlocking the real value of quality stocks over the long term. The time to invest isNOW.
3. Search for bargains – many quality large & multi-cap funds have corrected sharply. Phundo continues to recommend these on our platform. Top-up NOW.
4. Don’t Panic – in volatility there is opportunity. The above case demonstrates this principle.

Phundo has witnessed investors making mistakes trying to time the market. Buying high and selling low is the most common mistake. Markets on the other hand provide opportunities. All one has to do is Rise early, work hard and strike oil! Phundo does this effectively for you. So just SELECT, INVEST and RELAX at let PHUNDO make your money work harder for you.

Disclaimer: Mutual Fund investments are subject to market risks. Please read offer document before investing. Past performance does not indicate future returns.

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