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Markets fell in March. FIIs were selling and DIIs were buying. Markets came back in April when FIIs stopped selling and DIIs turned buyers. Are we looking at a reversal or are we looking at a period where DIIs could start selling and that could really be a double blow?
It is very early to say. We have seen steady inflows on the DII side so far. The last mutual fund numbers that came through had SIPs at close to Rs 8,500 crore. So while there is a lot of pressure in terms of net flows, including lump sum amounts, one needs to watch the SIP number. If that number cracks or comes off from Rs 8,500 crore level in the coming months, I would say yes, that should alarm us. Just going by one day’s data would be a wrong way to look at things.
I think the more important question is, would FII selling continue? April was fairly strong and benign in one sense. We saw very strong selling in March of about $8.5 billion. We had next to none selling in April, which helped. Now we need to watch May, because sentiment may be turning a little adverse with what is happening globally. With higher tensions between the US and China, people are worrying about earnings going forward and things of that sort.
Let us talk about FMCG stocks. Most of the FMCG stocks, with the exception of ITC, are trading at a 15-50% premium to their five-year averages. Will this trade sustain? It is a safety trade. It is a space where the collateral damage is the least, but stock prices are reflecting no premium, they are perhaps pricing in a situation where nothing could ever go wrong.
Even before Covid-19, we had a situation where these stocks were trading at a significant premium to their historic averages. What has happened post Covid-19 is probably a collapse in earnings of the other sectors; be it banks where we are getting a feel of what the numbers may potentially look like in FY21 and FY22, where we do expect a fair bit of damage because of the high provisioning numbers that may probably come through. And there are a lot of consumer discretionary stocks where sales numbers are going to be very poor in FY21 and one does not know of FY22. Everybody is building in very strong numbers for FY22 thinking we are going to see a medical solution to the problem.
Under such circumstances where there is a great deal of uncertainty regarding the medical situation, with regard to demand, lots of corporates are expecting that the recovery in the second half of FY21 may be not very strong, but mild. I am not sure whether that itself is going to come. Under the circumstances, where earnings growth is iffy, people are going to be willing to pay a slightly higher premium to areas of the market which are going to show little bit of resilience in earnings and consumer staples, consumer as a basket and probably pharma as a basket would probably show that. So I would think that until we have a medical solution, FMCG stocks will continue to have these higher multiples.
There is this huge pressure for infrastructure to kick start at an accelerated pace in order to really get the economy going once again. We have already seen construction start in bits but, of course, a lot more is expected from the government. What is your take on that angle?
Investment in the economy has not been a play from a market standpoint. Except maybe pockets of cement stocks, which have done reasonably okay, maybe to a lesser extent L&T, the infrastructure as a theme has not really played out well in the last four-five years. I do not think it is going to come back as a theme any time soon. There might be an opportunity in certain pockets, maybe road construction and cement, but not so much in FY21.
Our expectation is that cement growth in FY21 or cement volume decline could be as much as high single digit, maybe like 8-9% and probably recover in FY22 on the back of growth in roadways and potentially rural housing or affordable housing segments. If you were to ask me a particular area that I would want to play the infrastructure story, I would look at cement. So cement is a space we have been bullish on from a two-year perspective where we have been positive on largecaps like Shree Cement and UltraTech. Especially in Shree, we think that volume growth is going to be the key driver of the stock and the volume growth is going to come on the back of internal accruals and not so much because the company is going to take on greater debt.
Similarly on the midcap side, we like Birla Corp and JK Cement where we think that volume growth is going to be fairly good for Birla Corp and for JK Cement, we think that the grey cement side of the business should start doing well going forward. So cement is an area we would want to play if we think about infrastructure. I do not think that there is anything else that we would want to focus on within that space because we do not think investment is going to come back any time soon in a material way.
Beyond pharma, where do you see the first signs of recovery kicking in which would reflect on the markets?
I would kind of look at stocks in three buckets. The first bucket is the very resilient earnings bucket which has pharma and consumer stocks. So that is a bucket where there is a lot of earnings visibility; that is where I think one has to be overweight now in the very near term in the next six months.
The second bucket: as the lockdown gets lifted across the nation, it is probably going to be a very graded lockdown lift off. I would probably look at certain consumer discretionary plays which have got a fair bit of operating leverage but low financial leverage and I would probably look at consumer discretionary names like durables and consumer electricals. Those are the ones we think can potentially do well.
Probably even the auto sector. Auto is a space where the stocks are fairly well-managed. They do not have too much leverage on their books and in the time of social distancing and once offices start opening up, I would probably think certain parts of the auto sector can start doing well. We think especially of the two-wheeler space; within that, Hero MotorCorp is a stock we like. Obviously auto does not have the same weight as a financial sector but we think that is an area where we can probably see upside.
Within the financial space, while lenders are going to be facing a lot of problems in terms of asset quality and we do not have too much visibility on how things can deteriorate, there are other parts like non-lending space and the insurance space which we think is a reasonably large part of the market. So my stance is that funds are going to gravitate towards the insurance side. So we like SBI Life, HDFC Life and to a lesser extent ICICI Pru and within the midcap space, we like Max Life especially after the Axis tie-up. So those are the kind of stocks we think can potentially do well just beyond this lockdown phase.
From a longer term perspective, we would probably think stocks which have run reasonably well but have got both operating leverage and financial leverage, which will be your banks in one sense. I think the corporate banks, even some of the retail banks are the ones we have been overweight on from a two to three years standpoint when we think that an ultimate medical solution is definitely going to come through. So broadly, these are the three buckets we want to go overweight on. So in the immediate term, once the lockdown gets lifted, maybe auto, certain consumer durable stocks are probably going to run.
Pharma is everyone’s preferred play at the moment. What is your opinion when it comes to the kind of rise of interest that we have seen in the pharma stocks?
As a house, we have been bullish on pharma for a fair bit of time; almost for four years and we have got it wrong for three of those four years. It is only recently that the pharma sector started doing well. I think the market’s expectation is that while there may not be any kind of big earnings revisions upwards, there may not be material earnings cuts coming through because of Covid-related issues; so it is a stable part of the market from an earnings standpoint and that is what the market is looking forward to.
My sense is, the huge underperformance we have seen in the particular sector for many years prior to the last 12 months combined with the earnings resilience and the pricing pressure that one has seen in the US market; that is kind of abating. So versus a high single digit, double digit kind of pricing pressure one was seeing in the US markets, that has kind of come off to a low single digit level right now. So all those things combined in my view and I would say, the positioning of institutional investors in the market is they have been hugely avoiding this sector because of the underperformance that one has seen.
I think all those things are kind of coming together to take the sector up and I think there is a potential for further multiple expansion. I do not see potential for earnings expansion in a material way but I think it would be PE multiple expansion that could happen. That is the way pharma is going to probably play out. And within that space, while a lot of stocks have run up to levels we were targeting at one point; I mean our target prices have been hit in quite a few stocks. I still think that there is potential upside in Sun Pharma, Cipla and maybe to an extent in Aurobindo in the largecaps and in the midcaps and smallcaps space, we like Natco Pharma.
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