Talking to ET Now, Manish Sonthalia, Motilal Oswal AMC – PMS, says that while PSU banks are tactical buys for next one year, over a three-year period, the private sector banks are still going to win hands down.
Edited excerpts:
You have really created a lot of wealth for your shareholders by betting on Eicher but do you think the haloed days of Eicher are behind?
We have Eicher in the portfolio but I do not really think that the Eicher story is over simply because last month numbers have been slightly below expectation at around 17% growth vis-a-vis 25% growth. These were plant issues because chromium plating capacity was exhausted in one of their plants. They had to limit the production and once the chromium plating capacity comes up, January onwards you should be seeing better numbers.
We really do not think that the story is over due to competition and competition is launching a whole lot of bikes. I think the pull factor is still there. We really do not think that there is a demand issue. It is more of a supply issue even now. Of course, there are some pockets in some states which has seen some slowdown like Karnataka and Maharashtra. But we do not think that the PAN India story for Royal Enfield is really over. Let us see how the following months play out, it may be just a one-off phase currently.
Would that be the story with Maruti as well because there too, you are seeing players like Honda, Hyundai managing to beat Maruti's monthly sales numbers. We have all seen what Maruti as a stock has done. What would be the expense of valuation? The stock just knocking on 10,000. Is it going to be a similar story or do you think Maruti has a separate base and you cannot really draw the same comparison as what RE or Eicher has done so far?
Two-wheelers and four-wheelers are two different stories because let us say one car out of every two cars being sold by Maruti and that is not the case in the case of let us say two-wheelers. There are far too many players and too many product launches and (the capacities are varying across segment and so really not comparable. But again, four-wheelers have seen 6% to 7% volume growth all this month. So again, we have to look at the numbers as we go ahead into January, February, March and so on. It is not comparable I would think.
You have managed to beat the benchmark very handsomely by following a simple investment strategy of QGLP. Do you think the QGLP strategy will work this year and what are your plans to beat the benchmark? How exactly are you planning to achieve that? What would you be focussing on and what will you be avoiding?
In any bull market, there are basically three phases — high growth and high quality that move and all of 2016 and part of 2017, we have seen that strategy play out. Currently, what we are seeing is actually high growth and low quality and they will also come at a time when there will be movement upwards on low growth and low quality.
Just to give you an example, we follow that high growth and high quality. Currently we are seeing not so high quality names like construction, PSU banks or metals. These cannot be associated with two high quality businesses. It is more a function of prices. They will also come in time in future when this bull market will actually see the low growth and low quality names go through the roof.
All these names are a part of the index and obviously there will be ramifications on the index movement on account of these factors but this is how typically a bull market plays out and in our case also, it is not going to be any different.
In this sort of a situation what do you do? Stick with your philosophy, your process, the QGLP which has stayed? We are not going to compromise on high growth or high quality but they may not give commensurate return in the next one year as what we have seen in the last one-one and a half years. That is what I am trying to say.
Where do PSU banks lie in this entire pie because you just briefly mentioned they are all sitting at mouth-watering valuations barring may be a few cases which have seen some sporadic bouts in the year gone by? The first tranche of PSB recapitalisation has already happened for some of the banks with high NPA stress. Is that a pocket to bet on or would you say that 2018 is going to be buy more of the same story and you would continue to stick with bigger private banks?
PSU banks is a tactical allocation for the next one year but whether I am going to participate in my portfolio, the answer is a no. It may give better returns in the NBFCs and the private sector banks because over a three-year period, the private sector banks are still going to win hands down as opposed to public sector banks because the basic problems of credit appraisal and processes have not been fully sorted out. The PSU banks and then NPL issues of course are going to come down on a YoY basis but we may see this linger on till 2020 and we have the growth factor being a problem, particularly in the case of PSU banks where PCA has been initiated.
Of course, good quality assets are also going out of these banks due to PCJ and they are all migrating to the private sector banks. So the structural story still remains that the private sector banks are going to win at the expense of public sector banks. We are really not taking a tactical call for the next one year but the answer is yes, the PSU banks may outperform the private sector banks in the next one year.
If the macro scenario is going to deteriorate, cost of borrowing for NBFCs will change and there could be pressure on liquidity. Typically when that has happened in the past, NBFCs and financials have underperformed. What is the right way of looking at financials? They may give this cosy growth of 15-18% if you buy the good banks, but then the underlying macro bent is going to be strong for them?
No, they will continue to grow at 15-18%. There is no doubt about that but it is just that the valuation is not in favour of the private sector banks and NBFCs. In the next one year, it is all going to be about valuations and growth and because the returns and the growth has been more than fully factored in for the next one year in the case of private sector banks and NBFCs, that is why PSU banks may be outperforming the private sector banks in the next one year.
You mentioned that you have bought into insurance, let us understand why and what is the prospect for the non-life sector and the life sector?
Life is a case of under penetration of the category and the mix in the last five years has shifted away from the ULIPs to pure protection. This is a far more profitable business for life insurance companies and this is how the traditional insurance businesses have flourished. The big picture about life insurance is that the size of the opportunity set is quite huge. This is a tough entry barrier business because it takes a minimum of 10 years to break even.
Most of the life insurance companies in India have actually gone through that gestation period of 10 years. Most of them are profit making and the solvency ratio is favourable. Entry barriers are pretty high and you would not really see too many new players enter this space because you will have to spend another 10 years to break even. The industry is at is nascent stage, the cost structure has been aligned to suit the standards are the best in the industry.
Of course, there is room for improvement but they have come off a long way then what the situation was let us say five years back, the cost structure is aligned, the premium growth will flow into operating leverage and into net profit growth.
On a thumb rule basis, this industry should grow at around 18-20% for the next many years. Of course, it is all about what is the underwriting that you are doing. Again, what are the processes that you are following in the case of underwriting and that is going to differentiate one life insurance company from the other.
In the case of general insurance, the big opportunity set apart from motor pool insurance is also going to be health insurance and it is also going to be crop insurance as you go forward.
The big opportunity is in health insurance. There are not too many players out here but motor insurance is the largest pool. Again, there are reforms that are taking place in the space.
Of course, the efficient ones would be the ones which keep their costs under control and we have seen one of the largest insurance companies, General Insurance Company's magic. They are the most profitable general insurance company and the other companies are also getting there. A few of them have actually come out with that. They are also not quite bad but again the size of the opportunity is very big and cost structure will determine how profitable you are. The opportunity set is equal for everybody.
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