multibagger stocks: 85% of multibaggers came from private banks, NBFCs & specialty chemicals in last 8 years: Samit Vartak

Let us talk about your outlook for 2020. While the markets have been perched at those all-time highs, the macros have not quite played catch-up and the earnings have not been in tandem with expectations. What is the outlook for 2020 on these two parameters?
Overall, it is a very difficult thing to predict going forward. Investment is all about probabilities. If you have valuation in your favour, things work out. But I think it is more important as an investor to focus on individual companies rather than trying to predict the macro which is the most difficult thing for even the best of economists, forget the investors.

I would rather focus on the companies. There is a huge opportunity available because of valuations, especially, if you leave out the leaders — in the largecaps or the midcaps or smallcaps. There is tremendous value available today and generally if value is your flavour, things work out in terms of your investment returns.

But it is more important that you focus on leaders in each of the categories that you would be interested in, focus on earnings growth because India is where earnings growth is available. The last couple of years are not the norm. It is an odd period out and India should get back to earnings growth. If you focus on earnings, the category leaders and valuation, things should work out in your favour.

But since your last memo, lots have changed — corporate taxes have been slashed and there has been a resolution of the Essar case. Clarity is coming in with regards to the IBC process; How soon could we see an earnings revival? Is it going to happen this January or is it still a wait of another two to three quarters or maybe longer?
The biggest hurdle for our earnings growth in the recent past has been the interest rates. The credit cycle is the biggest problem for the Indian economy. This started in 2011-12 and then the credit cycle has slowed down over that period. The biggest problem today is that the interest rates that the companies pay is in double digits. It is 10- 11% whereas the nominal GDP for last quarter was 6.3%.

Until the interest rates are above the nominal GDP, it is extremely difficult for corporates to borrow. It is not just supply of credit but also the demand side of credit which is very difficult. There are certain steps, the most promising step for me has been the lowest tax for new manufacturing companies who would be able to set up factories and start by 2023. That itself should spur capex because once your tax rates fall, your IRR or the hurdle rate also drop.

But the problem is that this was announced in September. In order to plan your capex, to get environmental clearances, to get all kinds of approvals, it would take 9 to 12 months and even though things might be promising from that end, I would expect the capex cycle to revive towards the September quarter or so.

Hopefully, there is a tailwind from the global scenario because you would see that the agro commodities have started picking up. The commodities across the world are picking up and that is a good tailwind for the emerging markets. That should revive some demand on the global side and things are falling in place. We have a pretty much stronger banking, it is relatively strong compared to what existed four years ago. It is capitalised.

The banking system has been significantly capitalised and hopefully over a period of time once the economy normalises, the interest rates will come down because the repo rate is low. It is just that the companies who want to borrow the money have stressed balance sheets. Until the demand picks up, the lenders would not be willing to lend and it is a catch 22 situation where unless the balance sheet gets stronger, the lenders do not want to lend and even if they want to lend, they want to lend at a much higher rate than the nominal GDP. That is an issue which will get resolved over the next two to three quarters.

Let us talk about the trend in autos. Without a doubt, this has been one of the most beleaguered sectors. We have seen an across-the-board slowdown, getting reflected in the monthly auto sales numbers. Is there a chance of reversal in the trend?
Auto has structural problems in addition to cyclical problems. It is going to be very difficult to predict their revival. I would rather bet generally on overall capex cycle picking up.

The NBFC crisis has had a spillover effect. Credit growth has slowed down, the liquidity situation has tightened quite considerably. Do you believe we are out of the woods yet? What is the way forward? Are you selecting some of the quality names within the NBFC space as a bet for 2020?
Financial sector was one of the prominent sectors. I looked at the slowest period in the Indian earnings growth phase – which was the last eight years — and looked at companies which have been multibaggers or companies with 26% kind of CAGR in terms of return. I found that 68 companies in the top 800 were multibaggers. Out of them, 85% of the companies were commodity companies or companies which provide commodity services or products and the prominent ones out of those were the financials. So, private banks, some top NBFCs and specialty chemicals companies.

If you focus on a category where there are one or two dominant players and the remaining are weak, it will provide you with an opportunity to take market share away from them. That is the way to go forward.

-Samit Vartak

The common consensus was one has to look at B2C companies which are consumer oriented and which do not need much of capex to grow. The actual results showcased that the best returning companies were companies where they were having decent ROE, 20-25 or 30%, but they had a huge opportunity to grow and they had a huge opportunity to reinvest their capital. NBFCs or private banks are the ones where the growth opportunities are tremendous.

If you focus on the category where there are one or two dominant players and the remaining are weak, it will provide you with an opportunity to take market share away from them. That is the way to go forward.

You have been bullish on the chemicals space. What are you advising and any other pockets or midcap ideas that you would like to share?
Chemicals is a long-term structural story for India. Again, there you have to focus on the category leaders and look at players which have not benefited from the Chinese shutdown. There are players which have been doing pretty well over the last decade.

Many of these companies have become 20x, 30x and it is not just because of the Chinese slowdown. Chinese slowdown is something which has been lucky for a lot of companies, but you do not want to bet on luck, you want to bet on company managements which have seen this opportunity well ahead of time. They are the most efficient players, even if you compare them with global players.

Other than chemicals and financials, I am also positive on building material. You have to be very specific. Building material can be cement or tiles. You have to find a space where there is one or two dominant players and the rest are weak. You will find that in the steel pipes, which are used in building commercial space or infrastructure, airports, even the door frames and multiple uses and once the capex picks up, the demand is going to be humongous.

These players have gained market share plus they have grown even in the worst of the growth phase for India. Once the growth phase comes back, it is much easier for them to grow and there are many such players who have multiplied their sales at 25-26% over the last decade and are still available at 15-20 times multiples.

They have grown and their balance sheet is as strong as many of the consumer oriented companies but because it is a B2B business, you get such a great valuation and that is where the opportunity is today.