Dear Investor,

Stock Market Update

The global markets ended the first quarter of the calendar year 2019 with meaningful gains across most parts of the world. These moves were in stark contrast to the last quarter of 2018 where we witnessed a sharp sell-off particularly in the month of December 18. In our September 2018 letter, we had highlighted “After nearly a decade of near zero percent interest rates, we have seen the US Federal Bank begin to raise interest rates as inflation starts to creep back into the economy and unemployment levels reach multidecade lows. The rest of the developed world economies will likely follow on the path of slowing and eventually stopping their QE programmes and move towards tightening of interest rates.” Inflation led by stronger commodity prices and higher global growth expectations had started to become a worry. The US govt. 10-year yield had moved up from 2.3% in early January 2018 to 3.1% by September 2018 and the path of tighter monetary conditions seemed all but certain. By December 2018, the US Fed indicated that they would take a much gradual path of rate hike as risks to the economy had risen and by March 2019, they turned even more dovish to indicate that there would be no more interest hikes for the rest of CY2019. In a matter of less than six months, global economic expectations seem to have turned on its head with experts now worried about a slowdown and perhaps a recession in the United States amid slowing retail and housing data releases. Germany, the engine for EU growth narrowly escaped a recession during the last quarter of 2018 registering a GDP growth of 0%. This growth scare and continuing dovish stance of global central bankers has resulted in over ten trillion US dollars of government debt yielding below zero percent. It now seems likely that will have a prolonged period of easy money and loose monetary policy action to support the slowing global growth. This ‘easy’ money will once again scour the globe for assets that can provide a greater return/yield and higher growth. As we see in the chart below, after a correction of 1-10% across markets in the December quarter, we saw a swift bounce with most of the losses recovered across major markets.

^{Source: Bloomberg and B&K Securities}

Closer to home, RBI’s action on liquidity easing with a new Governor at the helm and rate cuts seem to have helped the local markets absorb the shock of the IL&FS crisis. While the NBFCs may not be out of the woods yet, the environment for them has improved even though their growth rates will likely remain constrained for a few more quarters. This slowing loan disbursals from NBFCs has manifested itself with clear signs of slowdown in automotive sales amongst other sectors. Another major development during the recent quarter related to the terror attack in Pulwama and the strong counter military action taken by the current BJP led government. Post this episode, most opinion polls have shown a big swing and raised the expectation of a Modi led government returning to power in the upcoming May 2019 general elections.

Amidst this global volatility and local news flow, QRC portfolio returned 2.3%* during 2HFY19. Nifty, the main Indian benchmark benefitted from the resurgent foreign inflows of Rs 470bn in the first three months of the year (against an outflow of Rs 330bn in 2018) and jumped over 7% in the month of March alone. The stellar performance of Nifty50 in FY19 however masked how narrow the rally was with >80% of the gains being contributed by fewer than ten stocks. The mid and small cap indices are still lagging Nifty’s performance over a 12-month period but did recover some of the lost ground from the earlier part of the year.

^{*Individual client portfolio returns may differ based on timing of their investments and specific instructions/circumstances. QRC returns are TWRR.}

QRC Portfolio Key Sector Exposure*

^{*Illustrative. Individual client portfolios may differ based on timing of their investments and specific instructions/circumstances.}

Fine Organics Industries Limited

We started building a position in Fine Organics (FOIL) after its IPO in mid-2018. FOIL is a specialty chemical manufacturer operating in the high-end oleo-chemicals space (use vegetable oil as base vs. most others using petrochemicals). The company was founded in 1970s and till date, has not raised outside equity – showing astute capital allocation and measured expansion through internal accruals and promoter funding. The IPO was a liquidity event for the owner families to monetize some of their holdings via an 100% offer for sale. Over the years, the company has diversified from being just a food additive player to plastic additives and is the largest slip additive manufacturer in the world today.

FOIL’s key strengths are its ability to set up capacity at an estimated 1/5^th to 1/8^th the cost of global competitors given its very experienced in-house project team – this team also continuously helps the company in maintenance as well as process optimization. FOIL has a diversified client base spread over 70 countries with the largest client being <5% of sales. The additives that FOIL supplies form a very small proportion of value & weight of the final product but are very important for the quality/texture of the end-product. Given this, product approval cycles can be 2-3 years in some cases and once a supplier is selected, clients tend to remain sticky. Also, the fact that the additives are a very small component of overall cost for the client, FOIL can pass on cost increases (albeit with a bit of lag). FOIL runs a state-of-the-art research laboratory in Mumbai where they can conduct pilot tests which enables them to be a part of the product development conversation with the client from a very early stage.

FOIL is amid a capital expansion cycle through multiple projects that will nearly double its production capacity over the next three years. Typically, when a company undertakes large expansion, the stock price performance tends to falter as the markets worry about higher leverage and execution challenges. In the case of FOIL, we take comfort from their execution and capital allocation history as well as a strong balance sheet and cash-flows.

All in all, given these strengths, we believe that FOIL could be a steady compounding stock over the years as they increase capacity in the faster growing food additive business and monetise their work in the animal feed additive space. The key risks we will be monitoring are raw material prices & supplies given their largest supplier is nearly 30% of requirement and execution & ramp up of the expansion projects.

Looking Ahead

While the near-term focus of the market will continue to remain on the general election results, global growth, Brexit and the outcome of the trade wars and talks between China and USA, at QRC, we continue to look for individual stock ideas that fit in our philosophy and process. We have steered clear from businesses that overly rely on government policy and believe that barring a growth shock in India, all our companies should continue to build on their strengths and grow at a comfortable clip. In fact, after the sharp correction in the small and mid-cap stocks (our major area of focus) seen during 2018, we are far more comfortable with valuations and are increasing our exposure. To that end, we have added four new names to the portfolio in sectors like financials, media, consumer staples and building materials with no exits since September 2018. We remain confident of our holdings and the respective management teams to weather any global and/or local slowdown and continue to make strong decisions on an ongoing basis for the businesses and allocate capital efficiently. We have continued to deploy more monies into quality names and will continue to invest at levels and prices where we find risk-reward justifies our action. Post nearly half a decade of tepid earnings growth for the Indian benchmark indices, we think a recovery in earnings is closer than before and remain hopeful of stronger GDP growth in India once a new stable government is formed.

We thank you for entrusting us with your money. We would love to hear your questions or suggestions.

Sincerely,

Team QRC