The “mega caps” or the 10-15 heavyweights that investors have bought into don’t have any left, according to N Jayakumar, managing director of Prime Securities.
“They offer optical safety but lies elsewhere,” he told BloombergQuint in an interview. Instead, investors should look at the mid-cap space, which, according to him, is rich in .
Jayakumar, however, doesn’t believe in categorisation of stocks. “Ultimately, you need to have sensible growth,” he said, adding the stock could even be a small cap.
“Investors who are not comfortable with picking ‘select stocks’ should get into mutual funds and SIPs (systematic investment plans),” he said. “If you are there in the markets and swimming with the sharks, you need to be identifying companies where financing is not a constraint.”
India’s equity market has witnessed polarisation within the NSE Nifty 50 since the index bounced back after surprise corporate tax rate cuts. The benchmark now trades at a 15 percent premium to its 10-year average, Bloomberg data showed. But nearly three-fourths of its constituents are trading at a discount to the historical valuation.
But Jayakumar said the equity market is moving towards a broader base. Investors are buying into a larger variety of stocks and sectors during dips, he said. “The confidence is also bolstered by the fact that the mid-cap space is extremely active and a lot of risks on trades pertinent to stocks that were hitherto not part of the market moves.”
NBFCs And Risk Of Bankruptcy
About non-bank lenders that have been battered since the shock defaults by IL&FS Group subsidiaries in September, Jayakumar said the market has painted the NBFC and private banking space with one brush, pricing in bankruptcy across the board.
“My sense is far from bankruptcy. Many of these will actually re-fashion themselves and come up new business models and actually come through in a slightly different avatar in the next six to eight months,” he said.
Jayakumar also expects non-bank financial companies to either consolidate or morph into banks, allowing them to reduce capital cost, provide better access to capital and a better reach and distribution mechanism.
Public sector enterprises, private banks and a few select NBFCs are a good hunting place for select stocks, he said.
Watch | N Jayakumar on Navigating Through Uncertainties:
Here is the edited transcript of the conversation.
What according to you has been the mood of the market off-late, in your conversations with various market participants?
The way we are seeing this, there’s clearly a fair amount of risk which is coming back into the markets. People are happy buying into the market on dips and the market has been gradually trending up. I think the mood is clearly underscored by the fact that every dip is getting bought into and that to my mind represents a market that
potentially could scale decently higher levels over the next nine-12 months. So, the confidence has also bolstered by the fact that the mid-cap space is extremely active and a lot of risk on trades pertain to stocks which are hitherto not been a part of the market moves where the market in general is hiding in pockets which are the two HDFC twins, Bajaj twins etc.
Today, I think the market is a lot more broad-based, the rallies are a lot more durable and I think the buy on dips is now stretching to many more sectors and many stocks compared to just a few which has been the trend in the past.
Do you feel that while we are talking about this risk on trade, for businesses as well the momentum has garnered more steam post the announcement of the corporate tax announcement. The risk appetite has gone up which is a prerequisite for acceleration in terms of growth numbers as well. Do you feel that they are playing out in a meaningful fashion over the next coming quarters?
I think the two sectors where risk is not back- one is the NBFC space, one is the real estate space. In fact, I’ve been pretty active in my tweets on both these spaces that the government intervention is absolutely vital here. Because one represents almost a third of credit in the system for the last several years which is the NBFC space. The real estate, that functions as an asset class which every Indian either wants to own or does own. So, from that perspective, we can’t wish away the problems on these fronts and I need the government to have a targeted intervention in these two spaces. Specifically, I can run you through two things that can be done where the government intervention would bring about added credit here, to these two spaces because both these are short on equity as we speak and therefore, debt from the domestic market; we are plentiful on debt on the domestic front.
Therefore, getting more debt into these companies for them to either complete projects in the case of real estate or onward lend in the case of NBFCs, the banks would have to see a lot more equity, a lot more skin in the game for which my call is that we need to bring in a whole bunch of overseas investors into these two spaces. In fact, literally throw open the doors, give higher than the normal 10 or 15 percent
stakes which are permitted in the banking space for overseas investors to invest in the banking space or the NBFC space.
So, private banks and NBFCs can both get tremendous amount of equity. NBFCs have no restriction today but as the equity comes in from oversea sources, you’ll have the added advantage of being able to raise that much more debt in the domestic market. The domestic market is awash in liquidity. So, getting debt is not a problem.
I urge you to look at these numbers. The first six months of last year saw a credit to enterprises from the banking system close to Rs 7,30,000-odd crore. That number for the six months of this year stands pretty close to zero, in fact slightly negative which means that virtually, there is no credit that has absolutely gone into enterprises and with the kind of risk-off mode which people have been in. So, for the first time, we are seeing with tax cuts, with interest rates now noticeably coming down and hopefully some transmissions coming through, we are seeing a possibility of risk-on
coming through in the economy itself. The market is seeing this. The market
presage the economy between four and six months. So, I expect come the next two months, there will be a fair amount of action on the ground indicating a return of
some kind of animal spirits to both the investment world as well as the economic activity.
Where do you think once this push comes back in and the riskier trades start to see their bets on, where exactly is the money going to go according to you? You spoke about the NBFCs and we’ve seen that the market cap of 28-odd NBFCs from the start of 2018 and the end of 2017, the composition is the only thing that has changed. The market cap has remained the same but the larger NBFCs have just grown larger and the smaller ones have just shrunk in size. Does that mean these are the stocks to be in and the other stocks which have lost market share are the ones to be out of?
Well, I think the market have painted the entire NBFC space, and the private space sector banking space with one brush and they are virtually pricing in bankruptcy across the board. My sense is that, far from bankruptcy, many of these will actually re-fashion themselves, create new business models and actually come through in a different avatar in the next six to eight months.
There will be consolidation amongst NBFCs, or they will be a morphing of NBFCs into banks. I think these are two clear trends that I am seeing emerge and at least we are prime of belief that the morphing of NBFCs is likely to be a very real theme.
When it happens, the cost of capital for NBFCs will reduce and access to capital will improve and the reach and distribution that they have created, the recovery mechanisms that they have put in place, all of these will kick into action. A lot of banks,
whether public sector or private sector, could do with the reach and the
niche focus that these NBFCs have. So, I think a combination of NBFCs and banks, overseas capital into both these spaces is a way forward. That buttressed with
some kind of intervention that the government can do; there are two specific ones I can talk about- on the real estate space which think could make a lot of sense.
One is to aggressively/stamp duty. Maybe half the stamp duty and share that hate with the state governments because stamp duty is typically a state government subject and a state subject. Now you could have another scenario where the governments could intervene and through NBCC which the government owned.
Actually the fund someone like the NBCC pretty aggressively with the view to take on multiple projects, NPA projects, complete those and through a reverse option, actually put these in the market. Today, a number of these real estate projects are
hamstrung by the fact that the builder of the banks have these at a higher than these on books. The inventories that the securities held; for instance, at a place like Parel, it held at Rs 30,000-35,000 a square foot where you go to a builder, today you negotiate bilaterally and probably get it down by 20-25 percent. Now, why should this be a bilateral trade? Why can’t banks and the others take over these projects and
actually put them in the market for instance at Rs 15,000 on the reverse auction basis. Let the auction determine what the right is. If indeed its too low, the markets will bid these up and at Rs 18,000 or Rs 20,000 it will taken up. I dare say that the time has come to put some of these large projects which are incomplete and seeming like ghost towns when you look at those. Essentially, when these ghostly hands, sometimes ghastly structures, need to be auctioned off at whatever price bring the project to fruition or a completion by bringing in the HDFCs, L&Ts of the world ensuring that the completed product is available and sell at whatever price it sells. That’s the only way to monetize inventory. In the stock market, when you have large amounts of stock to be off loaded, people use the screen because at one price,
transparently whether 20 percent or 30 percent down, stocks get sold
out.
That’s the way a transparent market functions and there is one thing that the real estate market lacks its transparency. Its opaque to a fault and it’s extremely difficult to figure out what you are supposed to get the price that you are supposed to pay, whether deliveries will come on time etc. So, my assessment here is that we need to aggressively sell down inventory at prices that the market can absorb and establish something like a clearing price for these. That’s the way forward for real estate.
That along with the government intervention for funding for last mile financing, a cut in stamp duty will actually galvanise the space. So, that’s the treatment if you will and the cure for the NBFC space or the private banking space is to freely allow overseas capital to come through to supplement the debt that is available.
This is something which has obviously given a lot of thought and considering we are talking about a sector where the only representation in terms of stock markets is that all of the companies are mid-cap companies. There are no large-cap companies in the listed space.
So, would you say its time to start taking bets in some of these companies
and also, is it time to push the reset button the mid-cap stock? Some say that it is not prudent to categorise companies and say, these are mid-cap companies,
or these are large-cap companies. You should just focus on the business potential of the company. So, it could land up being a small-cap company, but the business potential is such that it could be better off compared to a large-cap
company.
I think rather than categorisation, we need to be stock specific on investments and if you don’t have the ability to be stock specific, get into Mutual Funds and SIPs. But, if you are there into the market and swimming with the sharks as it were. You need to be there in the market identifying companies where financing is not a constraint. I think what has changed recently is that, banks now clearly want hard equity-backed financing for the debt that they put in. They want hard equity to walk in, this is not funny money anymore, crony capitalism is out of the window. So clearly speaking, we need to establish. The projects that are set up, have skin in the game for the promoter and when they do, there is financing available. Never mind the company is small medium or large, it doesn’t really matter. So I think categorisation is something people in the media tend to do, it is not required from an investment standpoint. If companies are good, well financed and well run, I think you will get your returns. I don’t think there is an issue here, but the intervention needs to be in the two spaces that I talk about for the economy as a whole.
Do you feel that in this current point in time when everyone is more focused on earnings as a whole, the last few quarters have been a drag? The hopes are that the second half of this year might be different on the boost coming in from lower corporate tax and we started to see that playing out on the bottom-line numbers of some of the companies that have already reported numbers? Is there still going to be a slightly more long drawn process because you’re going to see the impact of that on an immediate basis and if we were to compare what corporate tax cuts did for the U.S versus what corporate tax cuts will do for India, top line growth has not happened in any case even in the U.S so that’s what going to take time to show?
Topline growth at the end of the day, we are operating the past utilisations that are lower than full capacity in any case; substantially lower. So, I don’t think top line growth itself is a panacea for everything. I think as some of these start-ups have shown, turnover doesn’t mean much. Listed companies more than anybody else will tell you that ultimately you need to have sensible growth. I think those that are in the exporting space have challenges, especially the commodity linked because worldwide there are extreme slowdowns very visible. From an Indian standpoint, I think growth will take time coming through. For the moment, reduction in cost, establishing far more efficiency within the system may well be the first step before we see substantial growth at the top-line coming through which is more a demand-led thing which I feel is 2-3 months away. So, maybe Q4 is when I think top lines grow and bottom lines follow suit. So that might be two quarters away rather than one.
Do you feel that the slowdown that we are witnessing which has affected some of the larger sectors? We spoke of the NBFC but autos which were again, the chunk of the index constituents; their market cap has shrunk meaningfully. Valuations have come off there. Do you believe that this is structural or cyclical in nature? If its cyclical, then its really a good opportunity to get in because they are going to be tied over at some point.
I think auto could be structural as well because technology in terms of the disruption it’s causing in various spaces cannot be over-emphasized. So, I think the disruptor which technology is, is felt from a large space perspective from the auto space more than anything else. I think I would be a bit lost to say that it is cyclical and we need to bottom fish. I think these could be meaningful rallies happening right now which could be used for reshuffling your portfolio and getting out of auto stocks because I think you could have further problems ahead as many of these become a next-gen issue where ownership of some of these assets is not really the way people want to go forward. So, from that point of view I think we are better served at being light in the auto space than otherwise.
There was this entire conversation about how divestment is a theme is going to start picking steam and with the government now focusing on privatization, making sure that Rs 1.5 crore lakh is their divestment target which will unlock significant in some of the businesses. Do you then think it is time to think that some of these businesses under the lens and then make strategic investments there from a stock market standpoint? Until now, this was a no-go area because of the government holdings.
Well, I think there is no choice. The governments clearly indicated that they wanted to be out on as many businesses as possible. To that extent, stocks like BP sell, Container Corp etc. are in the hands of the private sector participants and will do exceptionally well. There’s no question about it and I think the pocket offers a . Of course we need to be a bit careful because some of these stocks have started running up already but I think divestment as a theme catches on and the sky is the limit as far as what the government can raise and we can invest as a new category as the PSUs have always been high on intrinsic but low on valuation. So, from that point of view, they offer a great pocket and we need to be clear that ultimately these will play out. Some of these PSUs are also very high on dividend yield so they offer safety from that perspective as well. So, the PSUs are a good place from a hunting ground perspective.
If you were to give advice to somebody to realign their portfolios, keeping in Nifty that we have got the Nifty closer to 11,600, obviously if you were to say this is on the back of the top 15 stocks or the top 10 stocks which have led to the index, bottom 35 stocks which are still trading at Nifty sub 10,000, what would the realignment involve in focusing which sectors primarily; whether it be your usuals or add a little bit of twist to it?
I am not in the business of making the calls; it is far more stock specific in the sense. As a firm, we are more in the investment banking space. We are not into the stock market per se the PMS or the selection point of view. Personally, if you ask me, I would look at PSUs to an extent and look at the private sector banking space for sure, some of the beaten down names. Maybe (I would) dabble a bit with one or two NBFCs very selectively at that.
The environment is such; even in terms of the private investment banking space, is it any different? We saw the IL&FS crisis last year. Around the Diwali time, that was the time we had just digested a few months of the IL&FS crisis. Mood and sentiment started becoming more cautious. Is that reversing a bit? Are you starting to get a feel of that?
As I said, the NBFC space is actually dominated by a broken business model. The old business model of leverage available and leverage to be used to grow is not there anymore. So, NBFCs need to be a lot more selective, they need to have a lot of more niche areas and actually try figure out what their core competence is. Many of them have morphed themselves into becoming direct sales agents for originating of loans; whether car loans, home loans etc. Some of them have morphed into becoming specialists of recovery. So, I think the old NBFC model of growth in the areas is not going to be there. So, weather NBFCs are doing a fantastic job on the recovery and the ARC side. There are some who are particularly doing a good job on let’s say the car loans or specific durable loans. So, we need to be clear as to which space do we want to pick but I think there’s interest in the picks there because valuations have come down to some book levels in many cases. I have looked on some of the beaten down names not some of the well-established names quoting down the three-and-half, four times growth.
You mentioned valuations; what is according to you, the focus right now? Is it divisibility or a tactical play based on mismatches on valuations?
No, I think the mid cap space which the space I look at most often is rich in and I think that’s the space we need to keep looking at. Some of the large and heavily invested stocks for the world as it were don’t offer today. They offer people’s safety and as much as people are rushing into those, but I think the lies elsewhere. Ultimately, the stock market will reward you if you are making investment in a space and not if you are a part of the crowd. So, I think that’s very clear. You need to look in areas that offer and you need to be there as a loan furrower.
A lot of this could come in back-ended, so you need to have patience to sit through while your conviction plays out. This is not going to be like everybody is investing in HDFC bank so let’s also jump into it and we’ll make money 20 percent CAGR; doesn’t work. At some point that will break, and I suspect right now the valuations that some of these mega caps are quoting here, there is no left. So, I’d rather be hunting where nobody is present than be present where everybody is.
Some people also that we have had conversations with have suggested to look at pockets and look at spaces which have stood the test of time and rather use the phrase of ‘Baptism by Fire’ so if you have seen these companies wither the storm, go through this period of volatility; that’s the space to be in. Anything of that comes across to your mind where you feel that this is the places where you feel are extremely turbulent, but they have managed to sail through?
I mentioned the spaces. Private sector banks, NBFCs; all of these have gone through it. Some infra companies, some road building companies. Many of these spaces are there.
Can you dwell a bit more on infrastructure and roads sector?
Companies that are there in this space have sold their projects to inmates and overseas buyers who’ve gone into it when the projects have been completed. So, they have established a track record of profitability, project completion, execution, efficiency etc. So, I’ve backed these companies who have pummelled out of shape in the market fall.
Would you stick to the larger names there, L&T and would there be smaller names?
No, these would be smaller, niche players. I specifically mentioned “road” as an example where there are two or three players who are doing extremely well, and their valuations are extremely attractive. We’d look at those, we’d look at a couple of names in the EPC space, but you have to be a bit selective there because the receivable cycles have got extended in recent times. So, you have to be stock specific and I am really not at liberty to talk on stocks.
Any challenges from a medium term that might have been full of?
Plenty of them, I think there could be challenges on so many fronts. The world is awash on liquidity and easing of easy money policy- maybe that can change, that’s number one. In India, if transmission doesn’t take place, you can keep cutting interest rates but if the corporate sector doesn’t get it, you’ll have problems there. That transmission needs to happen. Number three, you could have challenges of more NBFCs of more private sector banks coming into problems. So, the challenges are galore and that’s why, it’s not as easy and intuitive to say that just go into large caps and make money. I think we need to be selective but there are plenty of challenges around as we speak. I think, the more the challenges, the more it will be interesting to navigate the space.
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