Short Call: Time to book profits in midcaps? Tata Chemicals derating, Zee, Interglobe Aviation, junk jolt

Tata Chemicals reported blowout number for FY23, but a repeat of that performance looks tough if soda ash prices remain under pressure.

“The most important lessons in investing are learned in the tough times.” Howard Marks

Mid and small cap shares continue to rally, and the situation is eerily reminiscent of the bull market in second line shares soon after demonetisation in 2016. The bet here is that with falling commodity prices and easing interest rates, the earnings picture will only get better from here on. A word of caution from Citi though. In its strategy report, the broking firm has pointed out that the premium that investors are now willing to pay for mid and small cap shares, over large caps, both in terms of price to earnings as well as price to book value, are now above their long term averages. This despite earnings growth somewhat lagging that of large cap companies.

If you feel June quarter will be another great quarter for second line companies, them midcaps and small caps are the space to be in. Else, it would not be a bad idea to take some money off the table. That’s because when expectations are high, even the slightest of disappointment is not take well by the market.

Tata Chemicals

Till a few months ago, the narrative around Tata Chemicals was about soda ash prices continuing to rise in the foreseeable future. That story got a jolt in April as reports started trickling in about the Inner Mongolia Soda Ash project in China expected to become fully operational by December end. Tata Chemicals cut soda ash prices in April and has now again cut them again, clearly indicating a glut in the domestic market.

Tata Chemicals reported blowout number for FY23, but a repeat of that performance looks tough if soda ash prices remain under pressure. Which means investors may rethink the valuations they are willing to pay for the stock after a near four-fold jump in the stock price over the last three years.

Zee

The stock did not fall as hard as the market was expecting, following the SEBI order against founder Subhash Chandra and his son Punit Goenka for alleged siphoning off of company funds. Interestingly, open interest in Zee futures declined 3 percent, indicating that traders who had sold short may have used Tuesday’s weakness to cover their positions. This is also a sign that smart money already knew about the investigation being underway. That could explain why the stock had been underperforming for a long time despite no visible deterioration in operating performance.

How the stock fares from here will depend on an investor’s view on whether Sony was aware of this development. If Sony was caught unawares, it could mean a forensic audit, a likely renegotiation of the terms of the deal and a further delay.

Interglobe Aviation

The stock appears to have hit a cloud pocket just when investors thought it was still in take off mode. There are reports that the Gangwal family, one of the two promoter groups, is looking to further pare its holding in the company.

The Interglobe management has said that it has not heard from the Gangwal family yet, but some traders chose to book a part of their paper profits, sending the 3 percent lower. Interestingly, heavy volumes in the 2300 put options, indicating that this could be a near term floor for the stock price. CAPA’s Kapil Kaul sees Indigo reporting recording record profits in the June quarter and having a market share of 55-60 percent by the end of this year.

Rental relief

Average growth in apartment rents in the US has slowed down to 2 percent, compared to double digit increases just a year back, reports Wall Street Journal. That is a big relief to tenants who had to contend with rent increases as high as 25 percent in the last couple of years. But it is also bad news for commercial real estate investors who borrowed money to buy buildings in the hope of rising rents. While tenants are facing relief, the investors have run into a perfect storm of falling property values, low occupancy and high interest rates. That could also spell trouble for lenders who have loaned money to the investors.

Pause followed by cut?

Is the Fed done with its rate hikes now that inflation is cooling off? The popular view among Wall Street bankers and economists is: yes. But there are few contrarians as well.

From CNBC:

Just as you can resume a show you’ve paused, so can the Fed return to its regular programming of rate increases. Indeed, Santander’s chief U.S. economist Stephen Stanley argues the Fed will pause in June, only to resume hiking in July; BlackRock’s head of iShares investment strategy Gargi Chaudhuri thinks the Fed will skip while “signaling at least one further hike by the end of 2023.

Junk jolt

Headline equity indices are marching higher with relentless consistency, but pockets of the financial market are sending out SOS signals. Defaults in the USD 1.4 trillion US junk loan market have crossed the total for 2021 and 2022 combined, according to a Goldman Sachs analysis of data from PitchBook LCD. There were 18 debt defaults in the US loan market between January 1 and the end of May totalling USD 21 billion – outpacing the previous two years both on value and volume terms.

The failures underscore the pressure being exerted on lowly rated companies with large debt piles amid the unprecedented monetary policy tightening by the Federal Reserve.

China stimulus

With its economy struggling, China is considering a stimulus package aimed at supporting key areas like real estate and domestic demand, report Bloomberg. Already, some Wall Street banks like Goldman Sachs have warned that China’s real estate sector may be facing a multi-year slump, and could see an L-shaped move, meaning a steep decline followed by a gradual recovery.

From Bloomberg:

A key part of the proposed stimulus package involves supporting the real estate market. Regulators are seeking to lower costs on outstanding residential mortgages and boost relending through the nation’s policy banks to ensure homes are delivered, one of the people said.

Jungle Raj

With a tough EU law on deforestation on the horizon, several major investors say they could quit consumer goods makers with "risky" supply chains, reports Reuters.

The EU agreed in December on a new rule to prevent companies from selling into its market coffee, beef, soy, rubber, palm oil and other commodities linked to deforestation. Firms must prove their supply chains aren't contributing to the destruction of forests or be fined up to 4 percent of their turnover in an EU member state.

"The fines can be a risk for the performance of these companies in the stock market," said Henrik Pontzen, head of ESG at Union Investment, which has about USD 467 billion in assets under management and stakes in Nestle, Pepsico, Danone, Beyond Meat and L'Oreal.

There is no Planet B after all.

(Abhishek Mukherjee contributed to this article)