A trend seen in the market lately is that the rally has narrowed as it progressed. Since 2009 when everything was rising to now when select few stocks are seeing all the action, it is a contrasting trend we are seeing of a bull market narrowing as it matures. How would you explain this anomaly?
You always get this anomaly when there is some kind of a downturn in the economy. We are seeing some amount of downturn since 2016 onwards. Of course, it started off with demonetization and GST rollout, which impacted businesses and that has continued. In these kinds of downturn, you see a lot of earnings cuts across most companies, but quality companies stand out. Also, in last two years, there has been a very big amount of formalisation, which has further benefited the larger players.
So, you have had a situation in last two years where the bigger and the more efficient companies across sectors have done far better than the sectoral average or the laggards. For example, you have a Bajaj Finance doing far better than other banks or NBFCs or a smallcap FMCG company. Also as the flows have also been strong in last three years, they have got diverted into these quality companies which exhibited growth in challenging times. That is why we have seen such steep divergence which we have not seen before. We have not seen this kind of a slowdown in last 10 years.
Secondly, there have been very good flows, which was not there earlier. Had the flow been not there, probably the market would have been struggling more.
Indian economy is going through a phase of formalisation and consolidation. You see that in real estate and telecom — the number of companies operating in these sectors have come down significantly. But pharma is one sector which has over 100 listed companies. What could be the trigger that will lead the sector towards consolidation? In the above cases, the key trigger was either a court decision or RERA or demonetization, which killed majority of the real estate companies. Unlike these two sectors, in pharma the top 100 companies — both listed and unlisted — are all extremely profitable. If you focus on the Indian market, even a smallcap or a microcap company with Rs 200 crore revenue from the domestic market makes decent Ebitda and ROCE. So, I really do not see any kind of trigger for consolidation there.
Secondly, we remain positive that we should be seeing double-digit growth, probably for the next 10 years or even more. Because our penetration levels are extremely low. Our pharma size is smaller than that of Brazil, which is one-sixth of India’s population. As income levels go up, you will have a lot more people getting into formal drugs. That will clearly lead to a long runway for growth. I do not believe the sector will see any consolidation, but yes there could be some consolidation on the US part. Again, one needs to keep in mind that the US business is equally profitable. It is just that most of these companies are investing for the next phase of growth, so the profitability is not visible to us. Even US-focused companies make decent margins. So I do not think the sector is heading towards consolidation, because it is inherently quite different from real estate and telecom.
As proven wealth creators trade at steep valuations, does investing in laggards of the current bull run make sense? I am talking about Nifty companies that have given less than 50 per cent return in last 10 years — Vedanta, ONGC, Grasim or an SBI.
Taking a very blind call that the top 50 companies that have done well will not go up now or the bottom 50 that have done badly cannot go down would not work in this kind of an environment. If you look at the top wealth creators and if they still continue to grow, and there is no big risk on the horizon, they would still continue to deliver. If you look at the names you have mentioned, they were expensive two-three years back, but they still continue to deliver in spite of steep valuations.
On the bottom side, one clearly needs to see what has been the change in the business. For example, if you look at a print company which has done badly in last three years, there is a very clear disruption with people moving towards digital.
So while these companies may be available at 7-8 per cent dividend yield or very low price-to-book, their performance may not be a trigger to invest because there is a very clear trend that growth is coming off sharply. In fact, they are in the degrowth phase.
One needs to have a detailed analysis before taking a very wild call to, say, sell the top 10 performing stocks and buy the bottom 10. You have to do a very stock-specific analysis and may be a sector-specific analysis and see what are those risks that emanate, especially in the bottom part, and then take a call accordingly.
A historical trend has been that stocks that have fallen 50-60% rarely bounced back to their heydays. How does one go about stock picking from this lot?
The clear way is, you need to analyse why the stock has fallen 50-60 per cent. For example, if it is a commodity company and there has been a fall in the commodity price and that is the reason why stock has fallen, then one needs to evaluate whether that commodity price can bounce back. If there is a conviction that the commodity price will bounce back, then yes, it would make sense to invest in that stock.
Taking a very blind call that the top 50 companies that have done well will not go up now or the bottom 50 that have done badly cannot go down would not work in this kind of an environment.-V Srivatsa
The other extreme example could be if there is a very serious corporate governance issue, which has not been addressed, and the stock has fallen because of that. Or there is a big promoter stake sale or promoter pledge, which has not been addressed and the stock has fallen. In those cases, it would require a different type of analysis to monitor whether those issues have been put to rest or not.
So, the general rule is, typically stocks that have fallen sharply find it difficult to come back, but there could be exceptions. One needs to identify the reasons why a stock has fallen 50-60% and then see whether earlier prices at which they were quoting and those conditions can come back. If they can come back, then it makes sense to invest in those stocks.
Calendar 2019 was marked by divergence between the economy and skewed market performance. How did this force you to tweak your investment strategy?
First of all, I run a multicap portfolio and I capped my smallcap and midcap exposure. So that helped lessen volatility than what it could have been. The second part is there is a divergence between the economy and market performance, but a large part of it has come because flows have been extremely strong and those have come to the best performing stocks. So that has become an issue, because you cannot go overweight on all those stocks that have done well.
As part of our strategy, we are quite disciplined with what we follow and we continue to hold on to it. For example, I follow value strategy across my funds, and last year has not been a very great year for me. The bottom line is, I just continue to hold on to my picks and wait for the time that my strategy will be in favour, and that is when I would really do well. So I have held on to my stocks largely in last one year, hoping that there will be a good turnaround as and when the value strategy comes into focus.
With the US-China trade war over and a certain Brexit, what are the key risks that may hinder market’s move going ahead?
One clear big risk which probably the market is taking very lightly is the geopolitical one. We have had tensions between Iran and the US, that created some scare in the markets initially. But then they wrote it off. That is something, which clearly has the potential to disrupt global markets, and consequently our market as well, as we are not in a zone of a low valuation where you can be protected. So that is the biggest risk I see.
Besides, you will clearly need to watch out for whether Phase II of the US-China trade deal gets signed or whether Phase I gets revoked. The same holds for Brexit. The biggest risk we are facing today, which the market is probably not pricing in or is taking lightly, is the geopolitical one which can have a disastrous impact if it were to play out.
In last 15 days, midcaps and smallcaps have outperformed the headline indices. Would you say it is the beginning of a rally in broader market and a perfect time to enter?
Yes. At this point, I am quite confident that the broader market will do better. The main reason is, midcaps and smallcaps typically tend to do well when the economy is in a good position. As we see a recovery in the economy over the next three to four quarters, one would start seeing improved numbers from them.
The second part has to be correlated with the valuations, which have corrected significantly, especially for smallcaps, in last two years. Today, we have a situation where valuations are very attractive for them and there is an increased probability of growth coming back over the next four to five quarters. So a combination of that coupled with expensive quality stocks is probably making investors divert money to midcaps and smallcaps, which is what is helping them. I expect this broad trend to continue.
There would be some ups and downs. Smallcaps have rallied 7-8 per cent this month, but you cannot expect that every month. By and large, if I have to give a very generic view, I would expect the broader indices or the smallcaps and midcaps to outperform Nifty and Sensex this year.
What are your key expectations from the Budget? Do you think it will be a non-event, as the government has already announced a lot?
Over time, the Budget has been losing relevance. There are two, three reasons for that. One is most of the changes in direct taxes have already been done. Of course, there could be some minor changes. We have seen a lot of these changes being done outside of Budget as well. So it is not that if nothing is done in the Budget, you will not have something coming up in two or three months. We saw that in September when the Finance Minister announced the cut in corporate tax rates.
The same goes for indirect taxes. With GST, a lot of them have been streamlined and the onus of revising these rates is now with the GST Council.
What we look for in the Budget is what is the kind of fiscal deficit target the government is working on. Similarly, what kind of spending on infrastructure or fertiliser subsidy the government is planning to do. Those minor details are critical points that we would be looking for in the Budget. By and large, a large part of the reforms is already done.
Coming to the funds you manage, pharma companies have been dealing with a number of problems in the last couple of years. That has hurt the performance of UTI Healthcare Fund. Some analysts say this may change in 2020. How do you look at the way forward? Can this be one place to park money in this year?
Definitely, the pharma sector should outperform the broader indices this year. If I look at the domestic market, it has stabilised after the twin impact of demonetization and GST rollout and is now headed towards a double-digit growth in the medium to long term. In the US, there have been compliance issues and a lot of companies are facing issues with the USFDA. But today the kind of numbers we are sitting on, most of them are at the lower end and things cannot go worse from here on.
From a Street perspective, earnings cuts will be minimal now. The last part of the earnings cut has happened in the last three quarters. We could also be in a kind of growth phase for these companies, because the domestic market has stabilised and is in a growth phase and the US is also on the way to recovery. Combining both with the operating leverage, which is possible because of growth, there exists a possibility of an earnings surprise here which analysts have still not figured out.
The second part is valuations; which are quoting at a big discount to the market as well similar companies with similar return ratios and growth prospects. So, I would expect the pharma sector to do well this year.
You are going big on private banks and financials, going by December portfolio changes in UTI Core Equity Fund. This comes after a year of superior returns by them. How much growth do you see in them from here on?
In financials, our exposures are quite diversified. So, we have corporate-oriented banks, which have been going through some kind of a restructuring, but have stabilised in the last one year and performed very well. We still continue to bet on them, because the growth phase is coming and they have cleared up a large part of their
mess and are sitting on healthy capital. In this kind of a scenario, they are well poised for growth.
While valuations have gone up from the lows, they have still not touched the extreme. I think valuations are still average and with growth coming in, one will see a similar kind of returns in line with the growth that they offer.
Another pocket we have been quite focused on is NBFC, especially housing finance companies, where we believe massive consolidation is happening. This sector has seen a shakeout. Only those who have good access to long-term funds will be able to survive. That makes us quite positive on the housing finance space, which has a decent weight in the portfolio.
Another bet we have taken is on diversified financials, which include companies having everything from broking to asset management, because this represents a good play on the overall financial services and these are well managed companies with very good return ratios and promoter credibility. So, while we are in line with the benchmark rate, the right way to look at it is that financial services comprises different sub-segments — banks, HFCs, some NBFCs as well as diversified financials —effectively three-four different sectors and that makes us quite positive on them.
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