Are you using the market upsurge to book prof its or are you buying afresh? Are you using the market upsurge to book profits or are you buying afresh?
It is a time to buy fresh in the sense that this is not the time to reduce equity exposure. In fact, it is time to increase the equity exposure because there is now a consensus as far as the broad markets are concerned. Small and midcaps did bottom out somewhere around December to February and this is a new uptrend which could possibly be a multi-year uptrend. It could last at least two, three years and even five years. Different people have different views, but certainly post bottoming out, this is the beginning of a new uptrend. It is time to go out shopping in small and midcaps.
What have you been buying? What have you been buying?
My sectoral or stock preferences have not changed much in the last of couple of weeks. As far as the power transmission distribution space is concerned, CESC is also into generation. There are stocks like CESC, Voltamp Transformers, cable company KEI and among the auto ancillaries — JK Tyres, Swaraj Engines — are preferred bets and I would continue to be a buyer for wherever opportunity exists in all these stocks.
Why are small banks like Ujjivan, AU, Equitas not participating in this rally? Why are small banks like Ujjivan, AU, Equitas not participating in this rally?
They participated earlier than some of the other banks, post listing. AU had a very stellar rally. Bandhan had a very stellar rally, so did RBL. All the ones which got listed in the last two years had a rally at that time and are now in a phase of “range-bound consolidation.” That is quite okay. Fundamentally speaking, most of them are at fairly elevated levels in terms of price to book values while they still ramp up in terms of growth, setting up of branches, getting the deposit franchise and so on.
Most of those elevated valuations are on potential and promise rather than actual performance because we really do not have a long-term fundamental growth performance track record to really bank upon.
Having said that, the traditional private banks — Kotak, HDFC, IndusInd — have got not only excellent track records in terms of growth quarter after quarter and elevated levels of return on equity and valuations which are in the band of about 2.5 to 4 times. IndusInd would be a little less than three times, Kotak on a consolidated basis of about 3.5 times. HDFC is little more than four times versus an AU or any of these new small finance banks — all at upwards of five.
Obviously there is a valuation play which market is certainly looking at. That is why you have a rally in HDFC BankNSE -0.40 % and Kotak in the last few weeks. It is basically some sort of a catch up and I would still bet on the private banks as well a the well-established private banks namely a Kotak, ICICI, and HDFC Bank to put my money on rather than any of these new banks at this stage. Disclaimer we have exposure in HDFC and Kotak.
Is there any merit is some of the ADAG names? Is there any merit is some of the ADAG names?
I would look at Reliance Capital. It is about Rs 190 and it is a deep value at these prices. First, if we look at sum of parts, besides the NBFC which is part of Reliance Capital, they have holdings in the mutual fund business — Reliance Nippon Life Asset Management, a listed company, life insurance company, a general insurance company plus sundry other investments which they are looking to either outright sell or at least get strategic partners in all of them.
The problems with ADAG are well known, but what is key is the strong intent to set things right and they are open to selling stakes or selling businesses outright wherever they can raise money. Last year, Reliance InfrastructureNSE 0.27 % faced similar issues. It was not as bad as RCom but they sold the Mumbai power distribution business to Adani for Rs 18,000 crore, raised that money to deleverage Reliance Infrastructure to a certain extent.
Large parts of the problems in Reliance Infrastructure have been averted and it is in much better shape now than it was two years ago. Reliance Capital is the only place where for Mr Anil Ambani to be raising capital to get out of the problems and the intent is very clear that they are open to selling the AMC business. The IPO of the insurance companies — both general insurance and life insurance — probably should come out in the next few quarters as the market situation improves.
If we look at the sum of parts, Reliance Capital has terrific value. The consolidated book value is about Rs 575-580 and at a stock price of Rs 180-190, where all the businesses are profitable. Not a single business is really losing money and all of them are tightly regulated businesses and the chance of any hanky-panky going around is much lower.
Yesterday, the big underperformer was autos. There are some fairly bullish reports coming in on Hero Moto. What is your outlook there? Yesterday, the big underperformer was autos. There are some fairly bullish reports coming in on Hero Moto. What is your outlook there?
As far as auto is concerned, the passenger segment — both two-wheelers and passenger cars are concerned. It includes Maruti and Tata Motors, which has a domestic car business that is too small to be considered. The slowdown is for real; production cuts are for real and have been reported so far. As high as 25% production cuts for March or may be even the current quarter and inventory pile-ups in the system is going to be as high as two to three months, which is also very unusual.
The news flow is not very positive but from a valuation point of view, as far as Bajaj AutoNSE -0.16 % and Hero is concerned, much of the collateral damage is already there in the stock price. The fact is both Bajaj and Hero have underperformed the bull market throughout the last five years and even subsequently. They have just stayed in a 10% range. In case of Bajaj Auto, it is between Rs 2400 and Rs 3000-3100 and even for Hero, it has been an established range of about plus or minus 10%. Despite bad news flow, financial performance in the fourth quarter shows a relative strength, that is number one.
From a valuation point of view, valuations multiples are closer to what they were during the global financial crisis of 2008-2009. They are debt-free companies and even with lower growth, they churn out cash flows which are very robust. I see some strength and optimism there as the stock price seems to be suggesting. I would be a buyer in two-wheeler stocks both Bajaj and Hero. Even at these prices, if they declined based on bad news or bad reported performance I will continue to buy.
Do you believe that the market is sitting at the cusp of a profit cycle and what convinces you that we are at the beginning of this much awaited profit cycle?
I will take the second question first. Assessing what is priced into the market is a lot harder. We have come to the end of a big draw-down in investments. The government has a cyclically spent on infrastructure investments and if you look at public capex, which is the aggregate of central government, state government and public sector enterprise spending, that number is actually now at multi-year high.
We have seen counter-cyclical spending from the government on capital and capacity realisation in the private sector has been rising for the past two-three years. The balance sheets seem to have depleted in terms of capital stock and in another two years, utilisation rate across several sectors will be in the 90s at a point of time where companies will need new capacity. You need to start planning now because it takes about two to three years to put up new capacity.
Post elections, we may see companies start spending capital on creating new capacity. There is a very strong correlation between profit margins and investments. If the investment rate is going to go up, it will also cause margins to go up.
Revenue growth put in a bottom almost 8 or 10 quarters ago and has been accelerating since then because nominal GDP growth has been improving over the past couple of years. It is not about top line growth, it is more about corporate margins which have been suffering.
This is the most important premise regarding why we could be at the beginning of a new earning cycle. To put it differently, the share of profits in GDP is at the level it was in 2002-2003. It is about 3% of GDP. It peaked at close to 8% in 2010. The rise from 3% to 8% happened between 2003 and 2010 and resulted in Nifty earnings compounding in excess of 35%.
Market earnings growth was strong. Now we do not think that type of a growth may happen this time because we do not have the same support from global factors. In that period, global growth averaged about 5%. At this stage it seems like global growth is more likely to average 3% and therefore a more modest Nifty earnings growth of about 20% compounded over the next four or five years is not out of reach. That is the second part of your question.
Now on the first part, it is always difficult to assess what is priced in and given that earnings are very depressed, I do not like to use the PE ratio to ascertain the market valuations. I prefer using price to book. If I use the Nifty or the Sensex, price to book is about 3.1-3.2 times which is bang in the middle of its historical range. In 2002-2003 the Sensex was trading at 2 times, price to book and earnings were depressed.
It was a no-brainer to buy stocks. It took a while and there was pain for maybe 12 to 18 months but then you got a ferocious rally in stock markets and the Sensex went up 7 fold in the subsequent five years.
I do not think that type of return is on hand right now because the price to book is already at 3.2, it is not at 2 times. That gives me a feeling that the market is not completely oblivious to the coming earning cycle. It knows that it is coming but it is not at 4 times price to book or 4.5 times that the Sensex peaked at in 2007, when it knew that the earning cycle was on it and it was fully priced in.
We are somewhere in the middle and that gives me a feeling that some of it is known to the market but not all of it. By the time we are done and dusted with this bull market, the Sensex tries to book multiple is over 4 times and Nifty earnings or Sensex earnings have compounded by maybe 20% for four or five years. That is the framework I have in mind with respect to earnings and valuations.
Over the last few years we have seen demonetisation, GST. The IL&FS crisis played out. Now with the big election event coming up, could it delay the earning cycle recovery to a certain extent?
Unless we get exposed to one of the shocks like DeMo or GST again, I do not think it is likely to happen and therefore the earnings recovery will not get stalled just because there is an election event in front of us. Unless we get exposed to one of the shocks like DeMo or GST again, I do not think it is likely to happen and therefore the earnings recovery will not get stalled just because there is an election event in front of us.
Of course if the country chose to put in a fragmented coalition government like it did in say 1996, that could be a problem because then sentiment could get really bad and a lot of decisions that companies make with respect to investments could get delayed. That is one downside risk that we have to deal with.
In the near term, the other thing that we have to worry about is global factors. One is oil. We are at a stage in our economic cycle where we have limited tolerance to poor terms of trade.
If oil continues to outperform, copper which is my signal that there is a supply side with oil which hurts India, that could cause a little bit of a problem. The other thing of course is to keep an eye on is global growth. Indeed at this point of India’s own cycle, it does not want global growth to slip into recessionary territory.
Keeping those caveats that a) we do not vote in a fragmented coalition government; we get some reasonable strength in the government and we do not have to stare at elections in two years from now; b) We do not get a global recession and c) we do not get a sharp runup in oil prices, the earning cycle should be in a reasonably good shape over the next one to two years.
I am not assuming that we will get a DeMo or a GST type of shock. It was primarily the DeMo shock, coupled with GST which caused the economy to slow down a lot more and for a lot longer time than what we had anticipated. Those shocks have been absorbed.
The whole NCLT bankruptcy process has actually been working quite well and we are now seeing some good test cases. Whether it is IL&FS or it is Jet Airways, these are situations that were created after the passage of the bill and I am quite pleased the way these things are being handled right now and it seems that unlike past credit cycles, the next credit cycle may actually be far shallower because banks have now got recourse like they never had before.
It makes the whole banking sector very interesting. I am not too perturbed about what has happened with IL&FS. Yes, there was a problem with liquidity and NBFCs’balance sheets but a lot of that has now been absorbed.