Sensex-A Structural Change On The Anvil

Sensex exits: The decadal story Modi’s ‘resets’ are poised to transform the Indian economy over the next decade. Structural changes in savings patterns, disruption of the crony capitalism model and redefinition of India’s subsidy scheme are likely to drive down inflation and reduce the cost of factors of production whilst causing a short-term dip in GDP growth. The biggest investment implication of this is a sharp rise in Sensex churn. In this report we provide a framework to identity the 15 Sensex incumbents that are likely to exit the Sensex over the next decade, as the old order gives way to the new. We highlight that in the wake of irreversible external change, Sensex exit candidates underperform the index by 20% per annum until their exit from the index. As Modi disrupts the way the Indian economy functions… We believe that India’s Prime Minister, Narendra Modi, is driving three structural resets that will meaningfully change the Indian economy over the long term: (1) shift India’s savings landscape away from gold & land and towards the formal financial system; (2) disrupt the Indian model of crony capitalism model; and (3) redefine India’s subsidy mechanism (click here for our 23rd March thematic on this subject). We highlight the Government’s high profile campaign against black money and crony capitalism as a measure of its intent.

Thus, the old contract between business and politics seems set for a major overhaul over the next decade.  …the economy is set for a structural change These structural changes will disrupt the way business is conducted in India in much the same way that the liberalisation measures of 1991 ended the ‘License Raj’. In particular, we expect the “resets” to have three significant impacts: (a) Inflation should fall structurally; (b) GDP growth will be adversely impacted in the short term; and (c) the cost of factors of production should decline thus making it easier for entrants to go head-to-head with entrenched incumbents.  Sensex churn is set to rise Our analysis of Sensex churn across 10-year windows reveals that churn peaked at 67% (or 20 replacements in a 30-stock index) in the years following the 1991 reforms (1993-1995). From those levels, Sensex churn has fallen to a low of 27% (8 replacements) in the latest 10-year iteration (from 2004 to 2014). We expect a reversion to 50% churn, implying that 15 companies will exit the Sensex in the next decade.  Identifying the exit candidates Using Ambit’s proprietary methods such as The Coffee Can Portfolio, The Greatness Framework and the Ambit P-75, we identify a list of 15 stocks that we believe are the most likely Sensex exit candidates over the next decade. These companies are Tata Power, NTPC, Hindalco, Tata Steel, Hero MotoCorp, SBI, Sesa Sterlite, Bharti Airtel, Reliance Ind, M&M, ONGC, L&T, BHEL, HDFC and Bajaj Auto.  For those who believe that giant market-leading firms are highly unlikely to be kicked out of the Sensex, we highlight that all of the following firms were in the Sensex in 1992 – Century Textiles, GSFC, Bombay Dyeing, GE Shipping and Ballarpur Industries. The disruption created by the end of the ‘License Raj’ was such that all of these firms were out of the Sensex by 2002. Similarly, in 2005, all of the following giants were in the Sensex – Ranbaxy Labs, HPCL, Satyam Computers, Grasim Industries and Reliance Infra. No prizes for guessing what happened to these companies by 2015.