This is the right time for investors to buy in India, according to the head of nation’s largest portfolio manager, as corporate earnings can only get better from here.
For Prateek Agarwal, chief investment officer at ASK Investment Managers, which manages about Rs 19,500 crore for rich investors, optimism stems from two things crucial for corporate profits—tax and interest rates.
“There are two line items after operating profit—the interest rates and corporate taxes. Both are at the lowest levels than most of our period in history,” Agarwal said at a BQ Edge event in Mumbai. “Because of these two things itself, you should expect the profit-to-GDP ratio start to expand a bit.”
The central bank’s Monetary Policy Committee has lowered the benchmark rate by 135 basis points so far this year to its lowest in nearly a decade to boost growth as inflation remains within its target. Finance Minister Nirmala Sithraman slashed the corporate tax rate to among the lowest in Asia last month to stimulate growth from its lowest in six years. That’s expected to aid corporate earnings.
India’s profit-to-GDP metric is at 2-3 percent compared to 8 percent for the U.S. Investors must be more positive than negative as the ratio has a greater chance of moving higher, Agarwal said.
“This is like 1 O’clock in the night—the darkest hour. This is when the doubts are the highest but when you are in such a situation, if you can forgive six to nine-month kind of a period, things will get better,” said the head of India’s fastest-growing portfolio manager. “This is a country where things can’t get worse.”
India’s benchmark indices wiped off year’s losses after the surprise tax cuts with Nifty 50 trading 7.36 percent higher. But the broader market rout isn’t over year. Nifty midcap and smallcap indices have tumbled about 9 percent and 14 percent so far in 2019.
Agarwal suggests caution. Mid-cap stocks can only provide a “flavour” to a large portfolio and cannot hold the whole portfolio due to their difficulty to survive in a volatile environment and weaker chances of becoming large caps in the future, he said.
When the rules and regulations change, many mid caps falter, Agarwal said, citing the example of cement makers and mid-sized software services.
What went up in 1994 like mid-cap cement, never went up after that. What went up in 2000 like mid cap IT—with all the fat annual reports they generated saying transparency—many of them don’t exist today. That is the nature of the beast and you should appreciate this.Prateek Agarwal, Business Head and CIO, ASK Investment Managers
Agarwal’s Evergreen Picks
Agarwal, however, picked a few “evergreen” themes to invest as India moves to become a -5 trillion economy and incomes rise. “Jewellery is one such sector where, as the shift happens from unorganised to organised, the organised players expand their margins in terms of making charges and other fees,” he said. A similar growth potential, according to Agarwal, can be witnessed in fee-based businesses like asset management and life insurance companies.
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So Prateek, I would’ve started off by saying “kya lagta hai?”, but that is such an abused question because when I go out and people ask me, well, “kya lagta hai?”, I feel like holding my head and telling them “yeh matt pucho” but I’ll start off by saying, ”kya lagta hai”?
So, Acha lagta hai. But, a lot of times we associate the feelings for the stock market with the feelings for the GDP. The two may not be related. No, come to think of it, the U.S. market may have done better than the Indian market- where the U.S. GDP grows at 3.5 percent and we were doing 6-8 percent. So, the two may not be related. The two are related as far as probably the growth in earnings go. However, in economies with lower growth, the discount rate- the interest rate is also lower and that is the reason why today we are hopeful. Now, what is happening is because of slow growth and lower inflation, the interest rates in India have dropped and may sustain here in spite of the slippage on the fiscal that you may see; which means the asking rate for stocks to sustain in the current evaluation is lower.
So our thought is, that while on P/E, the market maybe looking a tad on the expensive side, but as soon as you bring in the lower cost of equity, they should be sustainable or actually a bit cheaper. So, that is the reason why over the last two or three months we have been talking any dip in the market as an opportunity to buy.
Does that conviction still stay? Because again, I think the common belief would be despite earnings not picking up, despite the global uncertainty, despite Donald Trump and all of that, dips are an opportunity to buy?
So, this is an opportunity to buy for long-term investors. For one reason that if things get worse for India, the reason for doing business goals—in terms of profitability, we are where we were in 2002. Many of you guys who maybe businessmen, say this. It’s so difficult to make money and the people instead of starting an enterprise are buying property and giving it out on rent. That seems to be more sustainable than doing anything else.
So it needs to get better. To put more context to it, in 2002 kind of a period, we and U.S.— both countries had then had a similar profit to GDP ratio. U.S. was higher than us. It moved up till 2008. They had the global financial crisis, the number cracked but then they bounced back up. So from 2 percent, they are now at 8 percent and we have come back to 2 to 3 percent.Now, do we say that the West profit to GDP keeps going up and we keep going down or do we say that there is a greater chance for us to move back up- reversion to mean versus some other parts of the globe. So if you are a long-term investor and you’re looking at this data, you would be positive on India rather than the negative. Now, has had that started to happen? Yes. We underwent a strong phase of reforms. Whenever the reforms happened, they disrupt the old ways of doing businesses. Some can adapt, some cannot. You see a massacre like you are seeing just now. But then, the businesses which survive the businesses, which have adopted have a clean field to expand and you’ll see a strong growth. So, I see the current period in some manner like the late 90s, you had a lot of reforms then. Try and find companies which were large part of the index in the 90s; in the 2000s—they’re very different. The same thing is probably happening just now.
The complexion of the index just keeps changing because even larger companies, forget smaller companies, even larger companies may find it very difficult to adapt to a new set of rules, new ways of doing business versus earlier. But whosoever comes in, will then have a great period to expand and deliver strong returns to investors. Government has a lowered the interest rates. So after operating profit, which is what it was in the hands of the corporates, there are two line items; the interest rate- we now have lower interest rates than most of our period in history.
Second taxes- and that too, again on the corporate side, we now have lower than any time in our history. So, going forward because of these two things itself; you should expect profit to GDP ratio starting to expand a bit. So, the thing is to be hopeful for the longer term. I did this presentation and I said, this is like 1 o’clock in the night—the darkest hour. This is when the doubts are the highest but when you are in such a situation, if you can forgive six to nine-month kind of a period, things will get better. This is a country where things can’t get worse.
So after operating profit, which is what it was in the hands of the corporates, there are two line items; the interest rate- we now have lower interest rates than most of our period in history. Second taxes- and that too, again on the corporate side, we now have lower than any time in our history. So, going forward because of these two things itself; you should expect profit to GDP ratio starting to expand a bit.
I’m just wondering in your portfolios as well, do you find this urge to act because the midcap end of the portfolio is for everybody in this room as well as for you might be under the water. One, acting on the short term is fun and interesting, but the other part is long term investing. I’m just borrowing this line from Guy Spier, he said, that two ways to do things right. One is fun and interesting, the other is long term investing. What are you doing currently?
He ceased having fun like 10 years back. So, on the midcap part, one, I just made one comment that when rules are changing, mid-caps find it extremely difficult to encounter changes in rules. We see it- in our business they have limited bandwidth. They do well within a set of rules within a marketplace which is conducive for them and they can keep running and growing for a period of time. But when you change the rules, change the regulations and then, many will falter. In a way, a new guy will come up. So that is one. Two, if you go back into history, what went up in 1994, let’s say midcap cement never went up after that. Relatively speaking to what went up in 2000, Midcap IT and with all the fat annual reports they generated saying transparency, etc, many of them don’t exist today. What went up between 2004 and 2008-construction real estate is the cause of problems today and so on and so forth.
So, that is the nature of the beast and you should and must have appreciated this. Very few of the mid caps have become large caps. Yes, while every one of the current large caps, were mid caps at one point in time. If you focus only on the mid cap part of the market, chances are your returns will be similar if you were focusing on the large cap just because a very large part of the portfolio will never make it. That is the part which is damaging overall returns. So our sense has been that mid caps can provide a flavour to a larger portfolio- they cannot or should not hold the whole portfolio. We believe and we strongly believe this. You have to get the next theme.
Mid caps can provide a flavour to a larger portfolio. They cannot or should not hold the whole portfolio. We believe and we strongly believe this. You have to get the next theme.
What was the part of the mid cap which went up nicely in the last few years that was Chinese-related. China wants blue skies, they will not have so much of steel, they will not have so much of chemicals etc. They are a hundred times larger than us. They don’t grow. Then also our guys can double over the next two or three years. And this whole part did very well. There is strong global growth. So, the mid-cap commodity companies in the country do very well. The thing is, you need either the same set of events repeating. So, global growth has to be stronger than what it is today for, let’s say, the commodity pack to move up or a new theme to emerge. So, a mid-cap part always does well when a new thing emerges. Now, we don’t see that and the hints a while I look at this data which says mid-caps have corrected now over the period of four years, their overall performance is similar to a large cap. Yet, I would want to stay away.
Another piece of data— mid-caps are what? Mid caps are a lot of commodity companies, on a lot of auto ancillary companies, are a lot of NBFCS, right? It’s of them, so they are cheap. They are cheap because if you have seen a price of hundred, they may be quoting at 10. Not because earnings have not collapsed. The other bet, all engineering companies, which again supply to commodities by the way. Other than these, for businesses which are doing well, they haven’t cracked. So, we recognise this. We had invested in us overall for the monies that we look at. 86 companies at our peak. Today, we are at 46 companies for the 22,000 crores that we oversee. Happily, for the mid cap that remains with us— all of them may have registered at a new all-time high in the recent past. Stuff like Gruh, stuff like an Astral Poly, PI industries. A very few of them have not done well actually. So, that is something to be recognised. Then, as I would be speaking, you would be thinking that these are names which are again, not cheap. So the part of the mid cap which is not impaired by what has been happening is also not cheap. So, in terms of expecting returns, why would that part do better than the larger midcaps, large caps?
So, that is how things stand just now. We would again start to hunt there: 5,000-6,000 companies once a new theme develops. Just think about it. What is it [the subset of the market that] you are looking at? You’re looking at a company which is shown to you. And, what gets shown to you? It's where things have been good... for a period of nine months or twelve months, for somebody to have noticed it and for that company itself to have become positive and stand in front of investors. The life itself is 2.5 years for midcaps. So now by the time you see it and by the time you invest in it, you are very close to the peak anyways. So, that is how it is. It is a very difficult part of the market. It is good for individuals to do it, good for funds to do it there.
Our fund, we’re able to do a good job of it versus large cap where you are looking for a concentrated portfolio. Then for midcap, you should look at long portfolios that allows the fund manager to get in various flavours, that allows the fund manager to still correct mistakes if the size of the fund becomes large. So, it is a very different kind of investing versus the other part of the market.
Okay, so let’s try and talk about maybe some evergreen themes because I can understand, I mean, for a lot of people, to be able to look at what is not obvious and then try and gauge the quality of the management, quality of the balance sheet, etc. and then make an investment at the same time while doing their own jobs is a difficult task. So let’s try and figure out where is it that you think the themes or the businesses are not looking good only for 2.5-year-period that you mentioned- mid-caps have a life of but maybe their shelf life is longer or evergreen for that matter. Anything that comes to mind?
Yes, sure. So, let us attempt this. If we look at our own lifestyles and for people who have made it the hard way, how or what will happen to the rest of the Indians over the next five to ten years. Whatever we did, when did we buy the first two wheelers? Maybe at 23, 24, and then when did we buy the first car? Maybe at the age of 27, 28. When did we buy the first house? A lot of what happened to us is what will get replicated to rest of the country over the next five to 10 years.So, a few thoughts. One, we are at amongst the poorest countries globally, forget Africa, the rest of the world. At $2,000 dollars per capita, we are at point in history wherein other countries who were there, had the fastest expansions. So from $2.5-2.6 trillion dollars of GDP to $5 trillion dollars, U.S. did it in eight, nine years. Japan did it two years earlier. China did it in four years. So if the government says, we’ll do it in five, it is great chance that we ended up doing it in, if not five, six. Okay, the per capita, we will have population expand.
Per capita will not probably double but will be slightly less than double. So close to $3,000-3,750 thousand per capita. Now, what will this money be used for? A lot of the basics of life would have been provided. Everybody will have a weather-proof houses, roti (food), kapda (clothing), and power provided for. You are hearing this happened in rapid succession. So consume what? Like, we’ll start with smaller stuff; may be biscuits, food, maybe firm garments which people do from a darjee (tailor) to branded garments to maybe doing more of jewellery. Those are things that people want as people get richer. They are very, very Indian desires. Buying more of automobiles kind of stuff. You can then find companies which have made it. So, if I take the jewellery sector, this is a place where a lot of what we talked about has happened. So the shift from unorganised to organised is very real. It has been happening for quite a few years now.
So, when I was young, we would go to our neighbourhood jewellers, so called family jewellers who will charge 2 percent for a bangle and waived that because we thought he knew us so well. And we will come back so happy after that. Today, you go and buy jewellery from people and we shop for a bangle, they charge 25 percent making charges. That is the shift from unorganised to organised that has happened. Now when the shift happened, this is a great place. People make a lot of money here. So, people will jump into it, competition will come in and you saw somebody from the North coming in like PC Jewellers, spreading, trying to spread over North India. You had a Tanishq come in from the South, you had others come from the South like Thangamayil etc. You had somebody from West like TBZ trying to expand over the country or somebody from the East trying to do the same. So, good opportunities happen, people spotted it, people tried to pounce on it.
So, if I take the jewellery sector, this is a place where a lot of what we talked about has happened. So the shift from unorganised to organised is very real. It has been happening for quite a few years now. So, when I was young, we would go to our neighbourhood jewellers, so called family jewellers who will charge 2 percent for a bangle and waived that because we thought he knew us so well. And we will come back so happy after that. Today, you go and buy jewellery from people and we shop for a bangle, they charge 25 percent making charges. That is the shift from unorganised to organised that has happened. Now when the shift happened, this is a great place. People make a lot of money here. So, people will jump into it, competition will come in. So today, you have one national player. If you believe that over time Indiansget richer and this trend continues, who is it that will benefit the most? That is what it is.
Then what happened? Now who is a national chain? The guys from South could not expand to whole of the country. Guys from the West stayed in the West. Probably could not go beyond Bombay too much. Guys from the North discredited themselves and so on. So today, you have one national player. If you believe that over time Indians get richer and this trend continues, who is it that will benefit the most? That is what it is. You get a good space, somebody spots it first. That always happens. But then, when others see that guy making a success of it, they also pounce on the same space. In many cases, market fragments. Okay, which is when money doesn’t get made. But after the skirmish, which happens in the marketplace, most die and you have the winners. They then can make money for a long period of time.
So unless they really goof up, chances are they will continue to make money for a long period of time and though that they find their businesses to be with. This is the consumption space. The other space is finance. Countries grows by 10 percent- nominal financial lending character will grow by 11 percent. Now, more than 10 percent. And this skirmish in the marketplace that we just spoke about- because this place is so well regulated, it doesn't happen. So, do we have more banks today than we had in 2002, 2003? Probably not. If we have, though the very small banks are doing businesses which the main-line banks never did those businesses, but they've expanded the market.
So in this space, if you are good and by now you know who is good and who is not. So, if you stick to who is good, they will have the tailwind of shifts away from not so good to the good and of course, that nobody knew who is entering or can enter and the fact that the marketplace grows overall faster than the economy itself. So, a great place to make money.
We today believe that this is the best place to begin to make money for the long term. Now, there is another space with your happening in financials which even more interesting. The fee-based businesses. That could be general insurance, a life insurance or an AMC. Now life insurance and AMC are both, in some manner, AUM-based, fund-based businesses. They collect AUMs and charge fees on the same and make their money. Life insurances have a more capital intensive way of doing the same. Mutual funds that don't even require capital once they are profitable.
Now I shall share some data with you. Most of us would have been to Thailand kind of a country. Now when you roam around, you feel you are in India because of the kind of crowds, the kind of wealth that you see there. Then on a per capita basis, they are three times richer. So they are at $6,000 per capita versus us at $2,000. They are just six crore of them. We are 125-126 crores of us and their side of mutual Fund industry is half of ours. So, that is our data that you should remember because what happens is, as people get richer and the richer get richer faster, they tend to not put money in the traditional avenues like bank deposits. They tend to use it, they tend to get better informed and put money more even if they want debt in mutual funds where, overall, over the period of a year you hope to make more money and that makes a mutual fund, a life insurance company and a very good business at this juncture in the country.
This is the thesis that we seeing some bit of it happening in the marketplace. So, over the last two years, markets have not been nice. Earlier, if you go back to 2004-07 period when markets were not nice, people pulled out monies. In this period, you have seen mutual funds get like Rs 6,000-7,000 crores a month net into them month after month. This is the equity, debt has further exploded.
So, this is a trend which is already happening in front of our eyes and the whole thought is that it will continue for a long time to come. And that is something which makes this space again very interesting. So this is something that we look for now, even if I want to give further insights into the manner of thought— it is not that everybody would do well. Who will do well? Who will do the best? A house with the best brand name? A house with the best brand name of the manager along this term track record and in-house distribution? So if you have all four, probably you will make more money than others. If you have one or two less of these four, you will probably be still profitable but make lesser margin than the first one.
The lesser you have, the more de-facto commissions you will have to pay to the distributors to sell your position to the end investors. So here again while we will have more mutual funds, PMSs over the next 10 years, but the names can be very different. So we will have most of the top 10, but of whatever is left, you will have a very different combination after the next 10 years. So, the idea is to be with guys who have a good brand name would be the distribution franchise. That is where the chances of success is the highest.
Capex, lot of people over the last 18 to 24 months have been citing this return of the Indian capex cycle and therefore go out and to invest into specific companies. I don’t think when I look at your portfolios that you’ve done that in a meaningful way, if you’ve done it at all. Why? Why do you believe in this capex theme and that Indian companies can make money or for investors?
Sure. So, we learned something in the 2004-07 period. One, capex means building stuff where there is no entry barriers. So in the first round, when the first set of roads happen, people make some margins, but as soon as the next round happens, you see too many new players coming in and competing away those margins. So, maybe you will see order books increasing, but margin goes away.
Two, these are businesses which tend to be close to the government. The idea should be to stay away because for most, corporate governance is always an issue. So, that is the other thing.
Third, capex apart from roads, ports, airports, which is what the construction companies do. So, while they will build in there- I’m not sure whether they will build their own P&Ls and balance sheets. We do need capex of the other varieties. So companies which make power plants, solar panels, windmills, etc—the newer generation products; there the challenges is that either it is happening in the unlisted space or it is happening in the MNC space. Look at it, the pace of change is so fast that most Indian companies have been left out. How many electrical appliance companies were there in the 2000s? maybe we have lesser names of any relevance today. You keep ramping up, you were okay with one kind of transformer, then you go to the next gen and then, you may go to the next gen. A number of companies that can make it up, reduces.
More and more of new-gen stuff happens in the private sectors. If you look at something like engine manufacturers; offshore engine manufacturers will put a range for the listed company and the other bit will happen in the unlisted companies. Now as the country progresses, obviously the size of the engines required will increase and less of what is desired will be in the listed space. More of what is desired will be in the unlisted space.
So, those are the challenges for capex and in the end, this is one country which continues to be capital starved. Whole world today has close to zero interest rate, but then, we tend to continue to be capital starved. If one part of the economy gets a larger focus for a period of time, the other parts starts to crave.
This is again something which keeps happening to the construction space. Roads, ports will be bid out, construction will start and money will flow in for a period of time. But then just because other spaces are crying for money, you find these spaces getting less of the monies in the next period and something else starting to get money which then makes people here starve for cash.
We have seen that story happen and happen multiple times over the past 10-15 years. So that is the other challenge that the capex space faces. So we have tended to stay away, not that we don’t have anything. We have played it through cement. So, anything happens in the country like airport, roads; for any kind of capex cement will be used. It can’t be imported. So, then there are few companies who can do it better than others.
We have tended to be with cement to play the capex theme or there are companies which have both—consumption facing items and something with benefits from capex as well. For example, a Havells- where switch gears, lights and fixtures would be consumption oriented, but at the same time they also do cables and all of that which can go into capex. So, you have a hedge bet or something like an Astral where makes pipes where the change itself from steel to plastic will provide a long period of growth plus the fact that they are leaders in this space and more and more getting adopted in building
So, we have tended to be with cement to play the capex theme or there are companies which have both—consumption facing items and something with benefits from capex as well. For example, a Havells- where switch gears, lights and fixtures would be consumption-oriented, but at the same time, they also do cables and all of that which can go into capex. So, you have a hedge bet or something like an Astral where makes pipes where the change itself from steel to plastic will provide a long period of growth plus the fact that they are leaders in this space and more and more getting adopted in building etc. So, you start with something which has a huge potential marketplace in front and even if one part does not do well and yet, you believe they will continue to find their place in the market place.
So, we want to be very sure of the growth prospect of such companies before we invest versus most. We are happier to be on the edge on the consumption side where we believe sustainability is less at risk.
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