Do you think a large part of the price adjustment and pain is behind us or is it fundamentally difficult to justify a bottom?
In the midcap and smallcap space, a significant amount of value is emerging in individual stocks. The broad indices have held up at least in the largecaps and that is explained by a smattering of six or seven large stocks which have continued to do very well in the first half of this year. That also explains why the Nifty or the Sensex have not had as big a fall as the midcap indices have.
But if you break down the index, you see the fall in a lot of the largecap names to the tune of 25% to 30%. So, value has started emerging in a host of individual names but this is more bottom up rather than top down. When we looked at individual companies back in December, I could find very little value in the market but today I am excited about topping up some of our existing holdings. We are finding new ideas at these prices. It is quite an exciting time from a bottom up perspective.
You are adding to your existing positions and you are finding new ideas. Where exactly are you hunting? What have you managed to treasure hunt in this kind of a midcap rubble?
We are finding that domestic industrials are giving a little bit of an opportunity. Manufacturers of various kinds are seeing some opportunity there. We are seeing some opportunity in the infrastructure space. We are seeing opportunity in the auto components chain. Barring the industrial banks, we find the private financials to be quite expensive. So, industrial lenders and small private sector banks is again where we find opportunity. Here are some of the areas where on a bottom up basis we think value support that is emerging.
Why is it that you are recommending staying away from metals?
Metals is a very very difficult sector to analyse. It is a global demand supply driven situation but that has been made more complicated by specific trade actions that countries may take. For example, India has in place anti-dumping duties on steel. There is significant uncertainty relating to the trade outlook between US and China. What that does to supply in the region is extremely hard to predict.
Metal companies may have very robust numbers and but it is very difficult to forecast where things will go from here. So, while valuations are cheap, the uncertainty about the outlook on a medium term is quite high. Thats why we prefer to stay away from them. This has actually been a historical stand. We have typically not invested in metal companies because it is very difficult to predict the future but yes the earnings are going to be very strong and valuations are very supportive. You could see a short term rally. We are a little cautious purely because of the uncertainties involved
What about pharmaceuticals? The dark cloud seem to have been long gone and it has been raining gains for pharma. Could pharma be what IT has been year to date and perhaps it will make sense to stretch yourself out of the usual largecap pharma names and have a more of a basket buying approach in pharmaceuticals?
Absolutely. When I covered the sectors, I should have mentioned pharma. We like pharmaceutical stocks very much at these levels, both in the largecap and in the smallcap space. We have seen a significant erosion of prices in the largecap space over the last two years and in the small and midcap space over the last one year or so. The valuations are extremely supportive.
A lot of the companies are net forex earners so and from a regulatory standpoint, the domestic pharmaceutical industry now knows what it needs to do to stay a clear of regulatory problems in the sense that over the last three years, the regulatory goalpost moved a lot and now the Indian companies are broadly aware about what they need to deliver from the regulatory perspective.
Going ahead, the accidents will be far fewer. But earnings will remain volatile because there is a huge pressure on raw materials emerging purely from China Blue Sky policy where they have been cutting down supplies and manufacturing for a lot of these products.
Also the forex movements and volatility could hurt the short term earnings because some companies have borrowings in foreign exchange and not everybody has all their revenues in the US dollars. Therefore, short-term earnings are uncertain but long-term valuation support and industry outlook looks very good to me.
You are saying you see a turnaround in PSU bank earnings. What has convinced you?
I am looking at the PSU bank earnings from a longer term horizon from the next four to six quarters horizon. I do not think that this quarter will particularly be exciting for them but if you look at the overall stock of bad loans the overall stock of bad loans is pretty stable right now. I mean it is growing but it is growing at very small percentage points, so the problem is largely well defined. It is significantly provided for not entirely provided for but significantly provider for. I am also hopeful that the resolution process through the NCLT courts under IBC will continue to progress and we will see resolutions to some of the NCLT lists which are pending in the courts over the next two to three months. That is a significant assumption behind my positive stance on PSB earnings from a four to six quarters perspective.
I also think that spreads have bottomed out and these banks over the last four to eight quarters have been under significant duress trying to manage their provisioning cost but with interest rates having stabilised and lending rates starting to look up. Some positive momentum should be seen in their spreads as well. Here you have a story where provisioning will probably start to decline on a four to six of quarter outlook basis, you will see better spreads. Growth will not come throughm barring the top three or four names. You have to be extremely selective but I think the worst is behind us in so far as the PSU banks are concerned.
A large part of the argument when it comes to investing in PSBs is to keep it with one or two stronger names. On top of the list we always find SBI and may be a Bank of Baroda. Do you think that there is merit in looking at the mid tier names as well?
It is a much harder call in smaller names. While the worst of the earnings disappointments or the provisioning cost may be behind us, buying some of the smaller banks within the PSU space is going to be tricky. They do not have growth capital. There is also uncertainty over what the government wants their future to look like. I am not suggesting that within the PSU space you should go value hunting down the market cap curve.
You should stay with the well managed banks — at least the banks had have the capital to grow. There might be one or two names in the midcap space which have the ability to grow but you have to be very careful. I would not recommend buying anything that is under PCA. It is still too early and there are far too many uncertainties to be able to do that.
You have made presentation on a dairy company. Is this one of those niche areas where you are bullish on the migration of unbranded towards branded or unorganised towards organised? Diary is a classic example where the so called doodhwala bhaya may no longer be viable and the market share would be eaten by organised players?
I do not think I am making a macro argument there. Parag Milk is a specific stock which is there in our portfolios. That is a stock specific story and they are moving up the value chain. They have several programmes underway where they are extracting cost from their income statement and they are working towards more efficient working capital management as well.
You are a believer in long-term secular trend. Give a theme or an idea which you think is a compounding story and which you will be happy to hold for next 10 years? What would be a classic 10-year or five to seven year compounder business?
We are value investors and value investing involves buying stocks that have fallen on hard times for some reason or the other. It could be a bottom up companies specific issue, it could be an industry issue. For example, more than a year ago, I was very bullish on IT services companies. Today we are very bullish on pharmaceutical companies so these are not five or seven-year investment arguments. These stocks are trading well below their intrinsic values.
If you were to look at a secular theme, one of the themes that we have invested in and we quite like is the logistics space, be it warehousing, whether it is value added packaging unpackaging, inventory management or transportation. That sector is going to do extremely well. We are still at a very early stage of disruption. You have a whole host of companies who are investing in that space and you will see a lot of competition from foreigners as well.
But the market leaders there are in a very good space to be able to grow 20, 30, 40% for next several year. I am making an assumption that GST is here to stay and there should be no let up in the effort on the part of the government to formalise the Indian economy.
The transportation, the logistic sector is going to be a huge beneficiary of that. So, select names in that area is something that investors can look to hold for the next three, five, seven years and the argument for secular investing, growth investing is one that works except that we as value investors tend to be more of opportunist rather than look at five, seven, 10 years of investing. We look at three years and we look at a scenario where something is going or has gone wrong with the company. We want to be able to buy it with the medium-term view that things will get better rather than worse so that is how we invest.