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Headlines are not in sync with what markets are doing. Right now markets are getting it completely wrong and yet price actions are not coming down?
In the short term, the market is always driven by liquidity and sentiments along with may be fundamental sometime. This is a market which has been driven by liquidity and also positive sentiments. That is where we always have been saying that it is difficult to time markets and wait for the right moment to go and invest. If you look at the valuations for the last six-eight months, at least the broader market valuations were quite reasonable — the mid and smallcaps and that is where a lot of interest has been coming back in the last couple of weeks.
We can debate whether things have changed in this basket or not, but clearly the valuations were removing all the entry-level risk for this segment and that is what some of the investors have utilised, putting money into this basket. While the market may still consolidate at current levels, when you look ahead, the mid and smallcap basket can give relatively better returns than the largecap basket.
Do you think that the fear of missing out is going to push it even further because spots of green are emerging in the broader markets. Also, where within mid and smallcaps would you recommend buying in?
Whether you look at large caps or midcaps, there are no sectoral trends as such. It is still more based on bottom-up evaluations and that is what we have been doing. There are lots of midcaps which are in a structurally good business, but somehow cyclically they are facing headwinds. Those are the ones where you can make money in the medium term. We believe that once the cyclical headwinds go away, the structural strength of the business will enable them to create more wealth for investors.
The non-leveraged midcap companies or the small cap companies are the ones which will benefit in the initial stages. Also one needs to look at the kind of operating leverage some of these businesses would offer because once the demand improves, a disproportionate profit improvement will happen in companies with excess capacity in hand.
What is really moving higher today is NHPC. It is 18% up. Vodafone Idea is up 7% and Power Grid is up 5-5.5%. Do you think telecom stocks will make money now that consolidation is inevitable?
We are still confused. While the industry has seen some price increases, we really do not know whether that is enough for making returns for minority shareholders and other shareholders. For example, we did a reverse calculation and according to that the sector needs at least 50% to 60% increase in tariffs to make it viable in terms of paying all the dues to government and other agencies and also to break even. I am not even talking about making returns to the shareholders. It is going to be a difficult scenario wherein a B2C business, you are asking for 50-60% further hike in tariffs which have already risen 25-30% in the recent past.
Nowhere in the world there is an example where the prices go up 70% to 80% in a B2C business without impacting the volume growth or the subscriber numbers. While there is a short-term optimism in this segment. We are really not sure whether all of the players in the telecom market today will be profitable going forward. To that extent, our positioning is not that overweight in this segment.
We have picked up a very interesting trend. Steel prices have bottomed out and between October and now, steel prices have gone up significantly. How should one read into this data?
Clearly some of the commodity segments have seen price stability and in some cases price increases as well. Clearly, there is some hope that is being built in terms of what is going to happen between US and China in terms of the trade tariff resolution and also in some pockets there is improvement in terms of demand that we are seeing in case of steel and cement as well.
Overall, some of the core industries have seen some kind of early signs of stability in terms of volumes and also, there has been an uptick in prices. In some cases, there has been a benign raw material pricing scenario as well. Putting all this together, some of these stocks really offer some upside even from these levels although they have performed well in the last several weeks. We continue to believe that maybe they will offer a further upside.
While everyone continues to be overweight on financials, is your view still out and out positive on banks or would you be a little moderate in your expectations on some of the bigger banks?
Whenever there is a slowdown in the economy that is going to hurt even the financials and we are looking at some of those financials where the problem is less. For example, the kind of banking stocks that we have avoided are those where there is a question mark on the asset quality and two, where there is inadequate capital. If you have inadequate capital or poor asset quality, I do not think things are going to turn around immediately and also as you rightly said the inflation has moved up so the wholesale funded banks may witness increase in cost of funding as well.
We have remained in a couple of private sector banks where there are no issues on asset quality and also on capital adequacy. We continue to bet on them and in terms of the non-lending businesses, we have bet on general insurance and life insurance and continue to avoid NBFCs and PSU banks in most of our portfolios.
Private banks have been a high growth pocket for the last 10-15 years. For the next five years, which according to you is going to be the high growth sector?
As long as our economy continues to chug along, this will remain one of the high growth segments. What is going to give incremental growth for some of the portfolio companies that we hold in our portfolios is the fact that nearly 23% of the country’s credit was coming from the NBFC segment and more or less, that has vanished. So that is the kind of incremental growth that is available for well capitalised banks which have not taken risk in the earlier cycle and which continue to have very good risk management practices.
Also, while PSU banks are still a dominant force in the banking segment they are still not what they were many years back in terms of strength. I think only the well run private sector banks will still have room for growth and even if the growth rates is not as high as what it was in the past, given the current slowdown, it is possible that at least some of the banks will deliver reasonably strong growth.
With DHFL issue and telecom trouble, if the economy does not recover, what happens to some of these banks which currently are A) over owned and B) private banks which are already trading at fat books?
That is where one will have to differentiate between the banks in terms of the questionable assets they have on their books in percentage terms and also whether there is enough capital to make sure that they get around this problem and continue to grow in a challenging environment. When you ask some of these questions, you will see that across the board, you may not find good banks in the private sector. There are banks which have had issues which are likely to have issues going forward.
It is a tough choice for the government to balance the fiscal constraints with the growth needs.-Harsha Upadhyaya
You will have to eliminate them and also look at valuation at every level. I do not think it is an easy call to say that all the private sector banks are good and hence we will continue to remain invested. Even within the private sector banks, the asset quality problems are different, the capital adequacy is also very, very different so depending on where you find comfort in all of these areas and also clearly looking at the valuation that you are paying for some of these banks you will have to make your portfolio.
I do not think banking as a whole will have a declining growth phase going forward. Yes, there will be a pocket within the banking where there will be asset quality issues and also maybe declining profitability and other issues.
You have talked about engineering, capital goods, cement, we have definitely seen some of those cement names gather a lot of attraction of late, even though earnings are still to catch up as is demand. What is your overall outlook? How are you strategising with regards to that pack?
Cement, clearly, has been one of the core portfolio positions in all our portfolios. We believe that from a multi-year perspective, it is unlikely that you will see too much capacity coming in and there is also a lot of consolidation in the cement industry. To that extent, this is an industry which will continue to have more pricing power over the medium to long term.
When you look at the immediate future, clearly this is seasonally a strong quarter, we have seen prices going up and sustaining in most parts of India. We have also seen benefits coming in from a raw material pricing perspective. Given all of this and also the hope that the government may do a lot of activities on the infrastructure side to kickstart the economy, clearly the interest is building up once again in the cement segment but our call is more from a medium to long term perspective.
We welcome what has happened in the short term but there is a lot of money to be made over the long term when the consolidation benefits keep coming to the sector.
Do you think the time has come to make that shift of higher allocation towards small and midcap schemes or do you think the larger part of your allocation should remain with either the balanced or with largecap funds?
We have been clearly suggesting that investors should make a gradual tilt towards mid and smallcap categories, looking at their own risk profile and return expectations. In multicap funds, where we have flexibility as portfolio managers to move up or down in terms of large and midcap allocations, in the last six months or so, we have increased our midcap allocation by about 4-5%. Clearly, we have been suggesting that investors should take a little bit of higher bet on mid and smallcaps and also in our portfolios. Wherever the mandate allows, we have been adding to mid and small caps selectively.
We are counting down to the Budget. What are your expectations from the Budget? Would it be more sector specific as we have been discussing with some relief to real estate?
Clearly, there are a lot of expectations from market participants on reduction of tax or removal tax in some cases. I do not know how much of it will be taken up by the government, given the fact that there is not much room to lose further tax revenues. Already we are running lower than expected levels in terms of tax revenue mobilisation. To that extent, we really do not know how much of that will be taken up by the government but in some cases, there is a genuine need that some of these are rationalised. As far as sector specific proposals are concerned, while the government has always looked at overall manufacturing or overall economy rather than looking at individual sectors and pushing demand or giving incentives to individual sectors, maybe this time around we would see some of the measures which will enable further improvement in terms of credit flow into the overall economy.
Maybe there will be some policy measures around that. Not that the Budget is the only platform that can deliver some of those policy measures, There could be some that we will hear in terms of improvement of credit flow to the overall economy. Secondly, we all know that real estate has been down for many years. There have been various issues concerning the real estate sector. There could be some time- bound incentives that could come in the form of some benefits to customers in that segment which will enable the real estate sector to come out of the current situation and enable more job growth and other activities.
So to that extent yes, it is a tough choice for the government to balance the fiscal constraints with the growth needs and that is going to be challenging. That is what everybody will look forward to in terms of the Budget highlights.
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