Alpha Moguls | Private Capex Cycle Isn’t Coming Back Soon, Says Prateek Agrawal

Rate cuts, dovish global central banks and falling benchmark yields have brought down cost of capital, triggering hopes about private investments picking up in India. The head of the nation’s largest portfolio management firm doesn’t share this optimism.Prateek Agrawal, chief investment officer at ASK Investment Managers, said there’s still time for the private capex cycle to come back. And he cited three reasons for his less sanguine view.One, the insolvency resolution process at India’s bankruptcy courts has slowed because of big companies, Agrawal, whose firm manages Rs 18,000 crore in assets, said in the latest episode of ‘Alpha Moguls’, BloombergQuint’s special series. That’s because companies buying stressed assets are themselves looking at deleveraging—Reliance Industries Ltd. and the Tata Group being the cases in point.“If such large groups are not comfortable with the amount of debt they have, who will come and buy more assets?” asked Agrawal. “The easy part of NCLT (insolvency resolution) is done, and it will get more difficult as we go forward.”Second, according to Agrawal, is that no private entity is looking to build in India because they can buy stressed assets for cheap at the National Company Law Tribunal. “You have a lot of projects getting sold at the NCLT, many of which would be good, built assets with no execution risks. Anybody, who the banks are okay with to have an incremental exposure, wants to buy at NCLT rather than build an asset.”Third, the nature of capex itself has changed, he said. Most of the new investments are high-technology capex—of the imported and unlisted variety, according to Agrawal.“Earlier, capex meant power and coal projects—BHEL (Bharat Heavy Electricals Ltd.) will supply and it (a company) will put up a plant in the country. Now, increasingly, we are moving away from coal to renewables, where everything is imported. Our import intensity of capex is very high. If not import intensity, then supply from the unlisted space is very high,” said Agrawal.Still, according to ASK Investment, there is an opportunity for investment. If investors do want to play in capex, he said, they can look at investing in cement and steel “which go into everything”.And if investors believe in the $5-trillion economy narrative, where the per capita income is expected to grow to $3,500 from a shade under $2,000, he advises investing where the Indian consumer will spend..Watch the full interaction here:.Read the full transcript of the interview here:.Is there a legitimate case for expecting sufficient alpha to be generated over the next 12 months, amid all this talk of slowdown—not just locally but globally as well?This question keeps getting asked these days, especially since last year was very difficult for alpha generation. This year, managers have a better chance to generate alpha, but it is not a high alpha year. If the earnings growth is confined to a small part of the market, everybody huddles there. If that is large part of the index itself, then generating alpha becomes difficult.If you look at last year, we had Reliance, ICICI, TCS, HDFC Bank, HDFC Ltd...all the index heavyweights did very well. And that made it impossible for people to generate alpha. Only four or five funds did it in any substantial amount last year.This year is better because, to some extent, these names have done their bit and many of them are fairly valued. Since the earnings growth continues to be narrow, my sense is the next 12 months will also be narrow in terms of alpha generation. But managers have a better chance versus last year. It will improve as we go forward when breadth of earnings recovery increases, but we believe that is still some time away..Do you expect earnings recovery to be back-ended? Is there enough reason that it will be? Or is it a wait-and-watch approach before somebody can confidently say that we are in earnings recovery mode?For the broader market, we believe there is still time before earnings come back—which is why I said FY20 would be a narrow year. But as we go deeper into the next four- to five-year period, various things will be seen.One, we do believe there would be recovery in housing sales. The budget did a great job by expanding the benefits from Rs 25 lakh to Rs 45 lakh. That is a big part of the economy. Now, between a husband and wife, you can now buy a nearly Rs 1 crore house—that it close to 90 percent of the housing stock which get built.When that part starts to do well, not only do the wheels of the economy start moving, but also people start doing interiors, etc. A lot of associated businesses start making margins.A big part of the recovery that will happen will also be margin driven. As long as the government does its job well and is the sole driver of capex in the country as of now, people get order growth but not margins. For sustained price recovery in markets, we need margins to improve from where they are, which happens when retail comes in a big way. I would really like to watch the housing-stock movement for that to happen..So, you are differentiating Pradhan Mantri Aawaas Yojana from this move simply because it was government-funded and therefore margin accretion was not there? But, this time around, there could be margin accretion because retail will come in?So, there is a scheme wherein government makes the house and gives it out. The other (scheme) is where the government gives benefits and people buy the house. In either of these cases, once the house is done, people want to do interiors, etc. and spend 10-20 percent of the house’s price for that.That is retail demand, and that’s big demand, because when It comes to the market, it has the ability to give margins to manufacturers. Otherwise, when the bulk of purchase happens at the government’s end—and the government is increasingly doing so over the internet and everybody competes—people are unable to make any significant margins.So, margins trajectory has to move up, and we believe housing sales is a good indicator for that. That we believe should happen in the next year or so. Let 2020 pass...2021 onwards.The other thing which is happening, which gives us a lot of hope, is that traditional wants of ‘roti, kapda aur makaan’ are provided for. Whosoever doesn’t have it, the government wants to provide it by 2022. After that, whatever per capita growth happens goes into consumption and savings. Hence, for a longer-term investor, we really believe these are the two spaces to focus on for growth.So, even if we don’t double-up and touch the $5 trillion-GDP mark, say we grow from $2,000 per capita income to $3,500 in the same period, we have more than $1,000 for consumption or savings. More and more savings will happen using newer methods other than bank deposits. So, we are betting on this.We build portfolio for medium- to long-term rather than immediate term. And these are the spaces we want to stay focused on..It may not look as dire as a recession, but if the slowdown is so eminent, would 2020 be a period where investors should not expect fireworks? Because consumption is the first lever in India and if that is not growing, the others may definitely not grow.We had 5.8 percent GDP growth in the June quarter. From that kind of a number, we do believe things will improve. The government spending has come back. The money, which was locked due to fiscal year change, has started to flow back. The small-ticket purchases from Kisan Yojana would start, and that should support consumption in a big manner.But that said, let’s hypothetically discuss what would happen if the slowdown persists.Everybody who is managing money today belongs to the era when India saw the worst possible slowdown. 1991 was the year when we pledged hold. There are people who came in the 1990s who saw the whole thing. People who came in 1994-95 saw what the recession was. But there are things which have changed since then.One, when you have recession, focus of a manufacturing entity shifts from production-centric to market-centric. You can produce only so much that the market can absorb and not the other way around. Any which way, we were importing the rest of it.Two, pricing becomes a challenge, especially if your recession coincides with global slowdown, and businesses start to incur losses.Three, what did not happen then (1991) and is different now, interest rates during that period, interest rates were more fixed and higher. So, you had a slowdown but you did not have a large interest rate cut. They continued to be what they used to be. Now, interest rates are much more market determined.If this slowdown persists, inflation will be low, and you would expect interest rates to go down. That again has implications on asset valuations, especially fixed return assets. For example, the power space—they would be valued higher. Even consumer goods companies, which convert a lot of their earnings into cash and are very high ROC (return on capital) businesses, would also be valued higher.So, even if we have recession, we can still grow. It is not a deflation kind of scenario because we keep adding manpower, etc. We should be prepared to encounter slower growth in such a situation. But companies can sustain that kind of PE (price to equity) ratio. They can see PE expansion because interest rates are falling..Do you expect consumers could expand PE from these levels?No. Fixed return businesses, which have a good cash conversion, and businesses with steady long-period growth and not a de-growth could expand PE ratios from these levels. At some point in time, people will start looking at them for yields. Utilities becomes good businesses in such times..Does cost of capital falling play into this as well, as there will be improvement on multiple counts? Also, RBI is finally cutting rates. From an yields perspective, it looks like interest rates can go down further. Do you reckon it will lead to utilities becoming attractive and a sharper capex revival? It was not a crowded trade earlier and it is looking like a crowded trade without asset prices moving up.We differ there. We don’t think capex will revive in a hurry. The government is doing a great job, but it is only the government which is driving capex. Private sector capex revival should not be expected in a hurry due to several reasons.One, you have a lot of projects getting sold at NCLT, many of which would be good, built assets with no execution risks. You can buy them for cheaper than what you would pay to build an asset. Anybody, who the banks are OK with to have an incremental exposure, wants to buy at NCLT rather than build an asset.Two, we suspect that the NCLT process may be slowing down because the big guys who were buying those assets are themselves talking about reducing leverage. Over the last month or so, we have seen, let’s say, a Reliance or Tata Group talk about reduction in leverage. If such large groups are not comfortable with the amount of debt they have, who will come and buy more assets?The easy part of NCLT is done, and it will get more difficult as we go forward.Three, the nature of capex is changing. Earlier, capex meant power and coal projects—BHEL will supply and it will put up a plant in country. Now, increasingly, we are moving away from a coal to renewables, where everything is imported. Our import intensity of capex is very high. If not import intensity, then supply from unlisted space is very high. That is something which is clearly happening.And, of course, capacity utilisation. If, for a broad spectrum of businesses, we’ve been witnessing a slowdown for some time, if the capacity utilization remains in sub- or mid-70 percent, where is the need to commit capex in the immediate term?We believe that there is still time for capex to come back, but most of new capex—which is high technology capex—is of the imported variety rather or unlisted variety. If you want to play the capex theme, you either do banks, which lend to them, or cement or steel which goes into everything. Cement is better and steel is more cyclical..If slower-growth arguments stay longer than anybody has penciled in, would multiples come down—for markets at large and the expensive names too?I think we should expect it because multiples are a function of growth and discount rate. So, discount rate will go down and that will lead to increase in PE ratios, but at the same time growth has bigger influence. If growth goes down, we expect multiples to go down as well. That is something which should be assumed.When we communicate with our investors, we make it a point to tell them that we do believe that consumer stock valuations are higher than where they should be. Over a period of 3-4 years, expect a valuation correction thus lower returns as compared to earnings growth. After 3-4 years, you would get an exit which is at fair PE..What about autos and other discretionary products?We could see very strong growth in some pockets. For example, If per capita income grows to more than $2,000, and we are at the cusp of that, white goods as a category moves up sharply. This season has been strong for air-conditioners, refrigerators, washing machines, etc. Sales of ACs and refrigerators were higher maybe due to heat, but washing machines also sold well. In many parts of the country, we understand refrigerators and washing machines were out of stock. So, these are the spaces where we do believe growth can sustain for a very long time of a very high order. That clearly gives hope.But yes, auto is slowing down for various reasons and not all of them are related to the state of the economy. No free roads in metro cities is a good reason to not buy a car. Most people take trains or some of other means of transport to office. There’s no place to park. The cost of ownership of a car is shooting up. Parking charges and fines are more than fuel charges. Plus, you can’t park near where you are going. So you need a driver who charges more than any other charges. So, overall cost of ownership is shooting up in metros and that is where you are looking at de-growth.Plus, near-term worries of moving from Bharat Stage-IV to Bharat Stage-VI and the transition to EVs are also creating some amount of confusion in the marketplace. Do you want to buy a premium car when in 4-5 years you will get good EVs? The resale value will go down, and all of those concerns..Would commercial vehicles withstand these pressures better?Overall gross tonnage can be expected to move up. But CVs are a sharply cyclical industry. After many years of strong growth, we do believe 2019 is a cyclical de-growth kind of year for heavier CVs. For LCVs, it may be still OK. That is our sense right now..How long could a CV slowdown last? Could it be a factor of how long does an economic slowdown last, plus a few months dependent on factors, or is it too quickly moving apart?Commercial vehicles are an alternate means of transport. Over time, CVs were gaining market share from railways, and it did provide a leg-up to the industry. But with DFCs (dedicated freight corridors) expected to come up in the next two years, that will have some dampening effect on CV demand. Plus the usual cyclicity which is being encountered...These things do bounce back. It is not structural. We don’t have enough truck, trails. So we will see growth in that space for sure. But 1-1.5 years of cyclical downturn should be expected..Your largest overweight position is financials.Financials is very difficult to overweight. It is 35 percent in the index..Would you believe that valuation multiple will stay with larger banks because even if there are hiccups, they will get absorbed but a smaller size book may not be able to absorb the hiccup and therefore valuations might de-rate?We believe financials are more big-boy business rather than small-boy business. Small boys have a lot going against them. So, they have to do very well for a length of time to really succeed. There are a few entities who are doing it—so, not taking anything away from them. But the network effect, which comes in as small banks grow larger, is immense. Can any large corporate in the country work without a state bank No. They won’t become large. State Bank of India alone accounts for over 20 percent of overall lending market share!Yes, there is an NBFC slowdown, but it is now getting compartmentalised. Businesses which are suspect for any reason—good or not—are simply not getting money at any price. If mutual funds lend those businesses money, people will take out money from those mutual funds. So, it is that bad.On the flip side, businesses which are good are getting as much money as before September last year and source-for-source they are getting money cheaper than September of last year.Banks are looking for risk-weighted norms. RBI has allowed banks to risk-weight their NBFC exposures. Earlier, only housing finance companies were allowed; now even NBFCs are allowed. Decent NBFCs, which were getting 100 percent risk-weight earlier, are now getting 30 percent risk-weight. So, it has become a very high ROE business for a bank to lend to such NBFCs in the current market situations.Mutual funds again are lending to such NBFCs, but liquid funds that could do about 6-9 months earlier are now able to do only three months. So, NBFCs which could keep rolling over their papers every three months are finding it difficult to do so now.So, while each source may have become a tad cheaper or similar to where we were pre-September 2018, on weighted-average basis for some NBFCs, the cost may be a bit higher than what they were because they are also raising money on their own—which is more expensive.Smaller NBFCs are getting less money which is allowing larger NBFCs to do well. Larger banks continue to do very well. One should expect to see banks report higher names and higher growth this quarter versus the last quarter.So business is moving from the not-so-good NBFCs to better banks. Good NBFCs continue to do what they were doing best..But good NBFCs and good banks are exorbitantly priced. What do you do then? Would you buy more?Yes. We are seeing increasing specialisation and specialists are able to perpetuate their reign in the marketplace. Others are trying, but they start with a disadvantage. They are prone to accidents and unable to scale up.You see this across industries. You see this in banking and financials even more.There are three good NBFCs in auto-finance space. There is one in consumer durables-financing space. Other have not scaled up. So, if you are specialist in a space and you are able to grow very well, then you have the market to yourself and you alone will be making a lot of money.We like businesses which are retail-oriented more than those which are corporate-oriented. We believe corporate is a space where competition is very high. Any good corporate, you’ll have five or six banks competing for a position or competing for any benefits they might acrrue.Retails is where the guy goes around hunting for rates. There is difference is bargaining positions. Smaller the retail, the more desperate is the guy and more money the lenders will make. You can create lot of value for your shareholders..Will growth in life insurance business gravitate to bigger brands? Will they continue to become even more expensive than right now or will a smaller player have a play? This business is largely becoming digital and in digital there are no distribution benefits. Distribution benefits may stay for the next 2-3 years, but digital is slowly taking centre-stage in insurance.The brand benefit stays. If you are familiar with an LIC and everyone in the family has life insurance from LIC. There is this comfort of getting it done from LIC. Other brands like HDFC and ICICI have built similar benefit over a period of time. They will continue to have that edge.Smaller entrants will have to make sure that their brand gets the same salience as some of the larger brands, but that won’t come cheap. Life insurance is a business where penetration levels are low. While people may have life insurance, it may not be sufficient for the amount of income they may be generating.The needs have changed, too. So, different kind of products for sure.We do believe that this is the space where long-period growth should be expected and seen. You need to have a combination of good brand and good distribution on the ground and, by extension, in digital. We would be happy to hold those names for the long-term to make a lot of money..Put in fresh money, too, at these levels?We are putting fresh money at these levels which we get from our investors into these names..Do you believe that there is room for listed real estate developers to grow multi-fold from these levels?We believe there is lot going for better-quality real estate players. The amount of consolidation that we are seeing, and we will continue to see, will be sharp. If you are a lesser brand and if you have patchy track record of execution, you will simply not get investors to buy into your project, unless you price your houses cheap. It then makes sense to partner big brands because even if you have to share, you will make more.So, we are seeing that happening across markets—more in Mumbai and Delhi but also elsewhere in the country. Real estate is a space where unorganized presence is very high. You should expect sizeable consolidation, which is of course good for players who are consolidating. Some of them are listed. But not all listed players are great. But some of them are good. If you see stock prices, they themselves tells the story. The stock price of real estate firms which are benefitting from consolidation are doing well.

Alpha Moguls | Private Capex Cycle Isn’t Coming Back Soon, Says Prateek Agrawal

The head of India’s largest portfolio management firm doesn’t expect private capex to pick up soon.

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