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It is raining dollars, approximately worth Rs 40,000 crore, in the last three months. With so much liquidity, bulls cannot put a foot wrong. I thought markets always followed earnings, macro and the long term economic outlook. Why are foreign investors blinded to what is happening in the real economy?
It is important to understand that in economic text books, we never had a concept called negative interest rate. This is a concept where I give you money and take back less money after one year. This is an unheard of economic concept. When you unleash that kind of stuff on the global economy, you are bound to have people taking risks of all kinds. It does not matter anymore because even if you do nothing, but keep getting some dividend; even if you do nothing but get 1-2% return, you are good enough from that basis.
We have seen this play out in a number of times. It is not the first time that the liquidity rally has played out. Unfortunately, India is different from the US and you are right in questioning this because compared to the US, where the economy is also doing extremely well, grounds up we are doing pretty badly. But the caveat is that though we could be doing very badly at the ground level, the top-tier companies have got a big largess in terms of tax.
If you remember the finance minister’s speech yesterday, there is a reference to a dividend distribution tax. The next Budget might take off the dividend distribution tax and so the listed large corporates will definitely benefit from the economic policy and the FIIs are going in there. The fact that the rest of India wants to party with everybody else is a different matter, but the key is economic policies of the government, global flows are marching together and taking the index up. You ride it because the government is with you at this point of time.
Let us try and map it and track it to the top. What stocks could you bet on which will make you richer in say a year or two from now?
I am a firm believer of the trodden path, I do not really venture into jungles and get lost. The last time we tried it was three years back. Believe me, we just managed to get out of the jungle alive — small and midcap space. So, I would still stay on the trodden path. The government economic policies are very clearly saying that large private corporate banks will continue to benefit.
We have a big power debt overhang on the nationalised bank and they may give you a little bit of fillip but eventually the chicken will come home to roost because power dues are going to turn into a big problem in the next 6-9 months. Nationalised banks are going to be an issue and the consumer and mudra loans will be written off again. Unless the nationalised banks are privatised and in which case you can buy it, I would say follow closely the path of the private banks. They are doing fine, they have a monopoly.
Pharma sector which has underperformed for some time, is ready for a big jump because they sorted out a lot of US issues. The domestic industries are doing well and there is no sign of price control. Corporate tax rate is going to give them some benefit; if dividend distribution tax goes, that is going to be big benefit.
The last one would be metals. That is also slated for a big bump because if the economy stabilises and growth returns, they are the first point where the demand has to come in. I would say, take the metal, pharma, and the private banking space. You are doing fine with your portfolio at this point of time.
How many more private banking names would you buy? Would you really touch a YES Bank and RBL right now? How much more of ICICI Bank and HDFC Bank would you hold in your portfolio?
Okay two points; one, historically one does not buy returns at the peak, you buy risk at the peak. When you are investing big time, you are investing more on risk than return because it is a liquidity filled rally and has nothing to do with fundamentals. So, it may come to haunt you for a long time. The only benefit is that even if there is a steep correction in the market or whenever global liquidity starts to ebb, or we have a high inflation in India, you would find that they will be the last point standing in terms of these four-five institutions.
If you were to be in this market, you got to be there because literally a telecom and four banks have a monopoly on the private sector space in India which is unprecedented in global industry at this point of time. You can keep buying safer, but we are buying risk at the end of the day. You might have to wait for the return longer, but let us not worry about whether they will be a buyer in those stocks because those have been tested in the last five, seven years. We have tested HDFC Bank and of course there is a leadership change which might change a lot of views about the bank, but so far on the fundamentals, we have had phenomenal returns on these banks. If you have stuck to Nestles and Levers of the world, you would have phenomenal returns.
I would say do not worry about largecap surplus, do not add too much. It is a risk right now but don’t worry too much because these stocks can go a long way.
You will get returns in all sectors but metal would give you perhaps the best alpha returns as the economy turns around.-Ajay Srivastava
If one works with the assumption that recovery will happen — be it at the end of this year or next year, as base has come down to a sub-5% GDP growth, where would the delta of recovery be higher? Would it be in consumption, autos, discretionary and durables or will it be in cyclicals, metals, cement or industrials? Which end of the market do you bet on?
You are assuming that there is a direct connection between the state of the economy and the state of the capital markets. The state of the economy is nowhere in comparison to the state of the market and that is why those two issues have to be delinked. Large parts of India will suffer and is already suffering in terms of the economic progress, growth, employment, etc.
But there will be a part of India which will benefit from the government policies and that is why we need to divorce sentimental thinking from low GDP numbers. The top 200 companies in the country are having a much better time with lack of competition and all other governance issues and all economies put together than perhaps ever in the history. The more the smaller shoemakers disappear, the more the Batas gain. The more the smaller condiment makers disappear, the more Nestle gains.
Secondly, who gains from the cut in the tax rate? The answer is the top 200 companies. The smaller guys never paid the tax because they were anyway losing money. I would say fundamentally that you need to divorce the economic aspect from the capital market. They are too far apart at this point of time. And they may be playing out in political compulsions and the results in state assembly election, etc. We may not like it, but that is what it is.
I believe today in terms of pure market, metals will be the outperformers at any point of time because given where they are today and the fact that most of them are debt-free at this point of time but at the low end of the earning cycle, with very low price to book, you just cannot go wrong in terms of doubling or tripling. Decent metals stocks will go at least to 1.5 to 2 times book value. Metal would be the first stage where we will get alpha returns in my view. You will get returns in all sectors but metal would give you perhaps the best alpha returns as the economy turns around.
Do you buy a pure India play like SAIL, a global interplay like Vedanta or a Europe plus India interplay like Tata Steel? It is a large sector and in India there are a variety of metal companies, ferrous and nonferrous. What would you bet on?
We are already placing our bets on two places. One is the non-ferrous. There are only two or three companies and you really do not have too much choice in the non-ferrous. There is a Nalco, a Vedanta and that is about all. We have holdings in both.
But steel could be a stunner because now steel is in very strong hands. All the players are in very strong hands. There is no need for discount in the market. The debt overhang is gone by and large from the sector. It should get some amount of government largesse in terms of orders or some concessions.
Non-ferrous and steel in that order would be the better plays and as a pure India story, I do not bet on global stories because if I have to bet on global stories, I would go abroad and bet. I am not betting on metal overseas. I am betting local on India at this point of time because if any revival takes place, you need more aluminium windows, more steel, more iron railway tracks. You need all kind of stuff. Without that, it is not going to work for the India story. I would say non-ferrous first, steel second and local domestic at this point of time.
Given that valuation discount of midcaps is close to a 10-year high, does that present a compelling opportunity? What are the businesses you would be looking at within the midcaps?
You have to focus on high dividend paying companies because those are the companies with steady businesses, low debt and ability to pay big amounts of money back to the shareholders. In fact. in some of the cases the returns are 7-8 and even 10%.
So instead of looking at an industry pack, you need to look at the divided pack of midcaps and say if the company can pay 5-7-8% dividend consistently on strong cash flows and since there is no capex need for any company in the next year or two, that is the segment you can focus on. I would say, do not look at industry, look at dividend paying as a criteria for midcaps because that will qualify all the decent companies in the bucket and you can then pick and choose.
Because midcap and dividend normally does not come together?
Yes, you are right but this is a peculiar situation, where you find many midcaps giving dividend yields of 8-10% even at this point of time. That is why I said it is one of the peculiar times of life where midcaps are not borrowing, they are not doing capex.
By definition, Rs 500 crore, Rs 1000 crore companies can be midcaps because of SEBI definition. You will find that they are giving very attractive dividends at this point of time. Their share prices have fallen dramatically but the cash flows are very good at and they are mostly deleveraged or are in the process of deleveraging.
I cannot find companies which are giving 8% dividend yield with market cap criteria of less than Rs 1000 crore. Maybe you have some different data, why don’t you educate us?
We have got midcaps which are giving us yield of between 5-10%. Definitely we have got at least 8 to 10 of them in our portfolio at this point of time. I can tell you one off the cuff itself. If you look at HEG — Rs 50 dividend, Rs 1,000 share price. It was Rs 950 share price not long back.
HEG must have given this dividend when they were in a bull run because there was a shortage of graphite electrodes. That was last year. It is like buying a commodity cycle when the year was great. The dividend was strong, may be that dividend would not come now?
It has come this year. Earlier, these companies were leveraged. So, when they were getting into a cycle, they were over investing even at the peak of the cycle. Now, the midcap story is that they have enjoyed the peak of the cycle, they have deleveraged themselves, not invested too much capex in the market and therefore are able to come out smiling at the end of the day.
That is why I said there is a qualitative difference in the top 200 midcaps which have not invested at the peak of the cycle, but used the cash flows to deleverage themselves and clean the books of the company. Take REC for instance. I would call it a midcap. It’s dividend is upwards of 8-10% if I am not wrong. Portfolio may go wrong in the next two years or so, but the dividend has been extremely strong.
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