Consumer Discretionary Stocks Likely To See Double-Digit Growth: Nilesh Shah

I think the possibility of 7,000 looks very remote. Of course, you could never say never in this market, but, 7,000 looks very very remote. I see a higher probability of the market heading to 10,000. I don’t think 10,000 is in doubt. It’s more a question of whether 10,000 happens in 2016, or it happens in 2017, or probably later. That’s the only X-factor here. Otherwise I think that India is on a very strong wicket. It is relatively well-placed. The whole downgrade and reduction in weightage for India is uncalled for. If at all, the best times for India are yet to come. Our sense is that India is entering a pretty strong growth phase, which we believe is unparalleled and unprecedented in any other part of the world, especially in the larger markets. So to that extent, we remain optimistic about India and Indian equity markets going forward.

Oh absolutely! I think that optimism slates from the fact that we are slated to grow at 7-7.5 percent for years to come. It could probably be the most durable growth opportunity the world is likely to witness over the next 10-12 years. And that makes us very positive on Indian equities. I think when India gets into this kind of growth phase, and with inflation sobering down, bond yields will come off, interest rates will come off, and probably equities will be the preferred asset class, not just for Indian investors but also for investors across the world. Given that perspective, it looks like Indian equity markets have been in a bull market and are likely to remain in the bull market.

Well for this financial year, probably the markets are factoring about 12-15 percent earnings growth. That’s the kind of band which it is factoring in. The first half of course did not live up to that range, but it’s quite possible that a lot of catch-up will happen in the second half. Corporate India has some favourable tailwinds, in terms of lower interest rates and in terms of a buoyant rural economy on the back of strong monsoon. I think these are some of the factors, and of course, there are events like the Seventh pay commission, Europe and more liquidity coming into the system. It’s quite likely that the second half is going to be a lot better. In the first half, we had growth of probably 7-8 percent, the second half will be closer to 15 percent. So may be on an average for the full year, it’ll probably hit the lower band of the expectations, which’ll probably be around 12 percent. The years post FY17, they could probably be stronger years. Because all the factors that I’ve mentioned come into full play. We see pretty good signs of the investment cycles picking up. It’s quite possible that sometime next year, you’d also see the industrial capex cycle pick up. It’s quite possible that over the next 12-18 months, all the different pieces of the economy, be it the agricultural and rural economy, be it the investment cycle or be it the evergreen consumption cycle, all three play out at the same time. Our problem over the last 10 years or so has been that at different points in time either the consumption cycle was strong, or the investment cycle was strong. Barring the period between 2003-2008 when both the things played out. I think we could probably get into that phase, maybe towards the end of 2017 or maybe towards early 2018.

Absolutely. I don’t think you have any bull market which just goes on and on without corrections and consolidations. These two are an integral part of the bull market. And we’ve seen these bull markets. So if you look back to the 2003-2008 period, we’ve had years like 2004, 2006 where the industry has corrected 15-20 percent. Even at the start of this calendar year we had situation when the indices did correct 10-15 percent. These situations and scenarios will always be there. Even over the course of the next 12 months as the bull markets unroll, you’ll see situations where there are corrections of 10-15 percent. It will present some good significant long term investing opportunities. Those will be opportunities for investors that are not there in the market. There will be opportunities for investors who want to increase allocation. I think those will be wonderful opportunities.

Well, the way financial markets function, they don’t really go by the specific number. The reality is that the last five or seven years, financial markets have been driven by central bankers. It’s not the investment managers, but essentially the central bankers who drive the market. I think when they take a hawkish stance, a 25 bps hike is not going to make a material difference, but the market will see it as central bankers taking a hawkish view. Then, when you have a 25 bps hike, markets will start factoring in that more hikes will come, sooner or later. That’s something that unnerves investors. Second, we’ve seen an extended bull market in global equities, with negative bond yields. In the global scenario, over the last 12 months, investors have bought bonds for capital appreciation and they’ve bought equity for yields. You don’t see this happening. It’s usually the other way around. With interest rates falling so rapidly, in some cases turning negative, you have this scenario when investors say ‘okay, now how much lower can the interest rates go and therefore how much those bond prices appreciate and therefore let me just go out there and buy bonds. And for equities he is seeing how much is the earnings yield, and if I can borrow money at say 0 percent or 0.5 percent and then buy an earnings yield stock, which is giving a yield of 2,3,4,5 percent, that’s a wonderful arbitrage. I think that’s a huge paradigm shift that we’ve seen in the last 6-12 months in the global financial markets. So, I think if there is a hike, you will again see a reversal of this paradigm shift. Investors will again say that the interest rates are going to go up, the dollar will strengthen, and if it strengthens then it will unleash another round of competitive devaluation of currencies around the emerging markets, which in turn leads to a currency war. I think a virtuous cycle becomes a vicious cycle. That is the worry which investors always have about the next move of central banks.

I think the biggest risk for India right now is the world itself. People are calling India the bright spot, the rising star, and I think those are perfect names to give. But, the world is not looking all that great. It is a messy place. Growth is anaemic and there are large geographies of the world that aren’t growing, be it Japan, Europe, they’re still struggling. In a way, the correction in the commodity cycle is putting a lot of pressure on the emerging markets. Big markets like Brazil, Russia, South East Asia have their own challenges in terms of growth. On top of that, we have a tsunami of liquidity which has been playing out all these years. I think that itself is a big challenge. These are things that are not sustainable. At some point we’ll see a course correction. When that course correction happens, I don’t think India will be an island of safety. There will be few days, few weeks or maybe few months, where India would be vulnerable to some of this impact. But otherwise, purely from India’s point of view, I think it looks pretty good. So if we have something going wrong with the global economy, especially with the global financial system, the actual global economy is kind of impaired. The global financial system right now is robust, but that’s probably the most vulnerable.

Yes, I think so and the fact that the markets have rallied a day after the U.S. Federal Reserve meeting shows that there is a consensus that, yes, it hasn’t happened this time but it’s just postponed to December and the probability of a hike in December just goes up to that extent. So somewhere I think it is still wait-and-watch mode that investors are in. And it looks very likely that if the U.S. Fed at the start of the year had said that we would have a rate hike, I think it will be difficult for the U.S. to come out of that situation.

In a way, managements have become cautious in terms of painting the future and that’s because over the last 2 or 3 years their optimism has been unfounded in the sense. Their expectations that things would turn around didn’t materialise. So we had a bad monsoon in 2014 and managements probably thought that 2014 is an aberration and then things would get better in 2015. 2015 was again when we had a deficient monsoon because of which the rural economy turned even worse than what it was. In 2016, yes, the monsoons are good but I don’t think managements want to get carried away saying that demand is going to get generated on an overnight basis. They want to take one step at a time and figure out how this will play out. I think that for example between now and Diwali there is a good demand I would not be surprised if managements start saying that financial year 2017-18 is going to be a lot better than financial year 2016-FY17. In fact you see some of the consumer durable companies for example already talking very positively, already being very optimistic saying that if last year or the last two years we have grown at 10-15 percent we think we have had an opportunity to grow at 20-25 percent in the coming season – that is between now and Diwali or now and Christmas. So my sense is that managements will slowly raise their guidance and I think they will take it quarter by quarter. I don’t think managements will step in and say that the whole of next year looks terrific, they will take it quarter by quarter.

It looks like the entire consumer basket, and more for the consumer discretionary, the tailwinds have never been so good in the last 5 years as they have been right now. From all points of view, because of the seventh pay commission, one rank one pension, the purchasing power is going to go up. That’s number one. Number two, the ability to borrow is going to go up because interest rates will be lower against 6 or 12 months back. Third, the choice has gone up for the consumer because you see more and more players coming in, thanks to online, thanks to digital. You see more choice for the consumer and fourth, of course, is the feel good factor which is likely to come because of the monsoon and the fifth is that second half of 2017 is going to be an election packed period and you see that in the past that there is a lot of spending happens before elections and with a lot of spending, you see a lot of demand for consumer durables, consumer appliances going up. In addition to that, the Government of India’s initiatives like LPG for all, homes for all, though these are slightly medium-to-long-term aspirational targets. All in all, the tailwinds are fantastic for the sector. In that kind of environment, a whole host of companies, be they kitchen appliances, companies which offer cooling solutions, travel solutions, tourism related solutions, hospitality, there are a whole bunch of opportunities which are likely to do well going forward.

Well in the short term, it looks like there are headwinds facing the sector. There really is no doubt about it. The spending on technology has become a lot more measured, a lot more calibrated especially in principle markets like the U.S. and Europe. That clearly is the headwind facing the IT companies. That’s number one. Number two is the duration of projects which have become a lot shorter. When projects become shorter, performance can become lumpy, a lot more volatile versus the secular growth rates we have seen in the past. These are the two big challenges that apply to the entire sector. But it isn’t the first time that these sectors are facing these challenges. Earlier on, there have been challenges and every time India’s IT sector comes out stronger. The principle proposition is basically the wage differentials which are prevalent in the U.S. and markets like India. A simple barometer is that if the average per capita GDP in the U.S. is $50,000 which is about Rs 30 to 40 lakh, an IT engineer or software developer could be taking home Rs 40 to 50 lakh a year. In India, that cost is still Rs 4-7 lakh. That arbitrage is still there. While we may not want to say it in this fashion because we will be seen as kind of sweatshops, this is a reality. This is the reality of offshoring. This is the compelling proposition of offshoring. This gap is not going to disappear overnight. It may take several years to fill this gap. Even if India grows at 8 percent and the U.S. grows at 2 percent, that 6 percent will take several years or a few decades...just to get that gap to narrow down. So that proposition remains. So in the short term, these specific challenges will remain. Having said that, prospects of the sector are one thing, and its valuations are another. So if you really look at the last five years, the Indian technology companies have grown at about 15-20 percent. Some of the smaller, more nimble companies have grown at 20 percent. These are companies which are reporting operating margins between 15-25 percent. These are companies which throw free cash flows and on top of that, post the correction, their valuations have become very attractive. So even if you forget the forward earnings and look at the trailing earnings, most of these companies are trading between a band of 15-20 price-to-earnings multiples versus the market itself, trailing earnings basis, trading north of 18 times, more like 20-21 times. The technology sector is already trading at a steep discount to the overall market. So my sense is that sector is going to be here. Prospects will remain good over the next many years and this weakness you have seen over the last one year and which we may continue to see over the next year, I think this is a fantastic opportunity to buy some of these technology companies especially those which have a differentiated offering which are kind of focussing on one segment, are niche players and therefore would have better tailwinds of growth versus some of the big boys. We should stop painting the entire sector with one brush. Every company has its own strategy and we need to figure out which company is relatively better positioned as compared to the entire sector for the foreseeable future.

Some of the principles in your daily life like patience, discipline is where your temperament comes in and I think equities is as much about temperament because there will be those situations where things are bad or things are too exuberant and you need to be able to take a step back and say that I probably need to be more balanced. You need to display a lot of equanimity in equity markets. So these personal traits according to me are extremely important. So that’s where a lot of things you see in your personal life have a bearing in the way you manage equities.

I don’t think there are any e-commerce companies that make money yet. And you don’t know enough about them, at least the Indian companies. So I would wish that more of them turn profitable and once they turn profitable, then it expands our investment universe and presents an opportunity. But some of the global e-commerce companies like Amazon for example, what they are doing is incredible and I think they have built a strong moat. And I am quite sure that over the next 5-10-15 years they will be a lot more valuable versus where they are today. So we as investors have a small window to invest overseas so you could probably take advantage of that window which is available to you to invest into international markets. From the Indian space, I don’t think too many of them are making profits or cash flows. So it’s too early.

I think I would spend my weekend by going for a movie. But reading is very important. I think that is one simple habit that everyone needs to develop to be a successful investor. The books that I have benefitted from tremendously are books written by people like Peter Lynch – The Peter Lynch Way of Investing – and then some of the books of Warren Buffet. There are enough books written on him. In addition to that, because we are in a digital world, and a lot of new things are happening, it’s important that apart from books, it might just be very useful to read annual reports of companies like Amazon, Google etc. These are the kind of commentaries that these companies write or CEOs write. It helps to get a peek into the future. So it will be a fantastic combination where people like Peter Lynch and Warren Buffet are of the old school of thought who look for established companies and value and here are companies like Amazon and Google who are all about the future.