BQ Edge | How India’s Top Fund Managers Are Reading Modi 2.0
A stable government will aid Indian equity markets but a global slowdown and liquidity shortage remain the biggest concerns.
That’s what emerged from discussions with three market veterans Nilesh Shah, Vikram Kotak and Basant Maheshwari at the Mumbai edition of BQ Edge, an on-ground initiative of BloombergQuint.
The spectre of a coalition government had cast its shadow in the run-up to the elections, and now that it has been put to rest, the political risk is out of the way, said Shah, founder of investment management firm Envision Capital. One of the reasons for the markets to do well despite lower earnings growth since 2014 was the absence of political risk, he said. And that’s why he stays optimistic for the next few years.
Insolvency and Bankruptcy Code, Real Estate Regulation Act, Goods and Services Tax will have a slowdown effect, he said, crediting the Bharatiya Janata Party government for persisting with the landmark laws. “Reforms of 2017-2018 will show the positive outcome in 2019,” he said. “The biggest bet would be identifying themes which will benefit from the shift of business from the unorganised to the organised sector.”
Vikram Kotak, co-founder and managing partner at Ace Lansdowne Investments Services LLP, expects the next five years to be the best for the Indian equity market. While good quality companies will continue to do well, he doesn’t expect markets to reward mid caps ad hoc. Quality mid-cap stocks will get rewarded disproportionately due to the PE multiples and some of these businesses are seeing a re-rating, he said.
Basant Maheshwari, author of The Thoughtful Investor, is cautious. It’s back to the old grind, similar to 2009-2014, and the change in the international markets will weigh in, he said. “Foreign investors will really move the market, and because that scene is looking sketchy, a few concentrated stocks in which FIIs are interested will do well.”
Shah agrees with Maheshwari on this. “It’s going to be very difficult to predict if we will have a broad-based growth or not, and most importantly about its timing. The principal reason is the absence of a pickup of investment cycle over the last 10 years, he said. “When the investment cycle fires, it will touch a lot more aspects of the economy compared to the consumption cycle.”
All three market veterans agree that the first budget and the first 100-day plan of the government will be critical. Softening of rates and a fall in cost of capital will be among the key requirements for investments to happen, they said.
Watch the full video here:
Here are the edited excerpts of the interview:
Do you think from an equity investors perspective, the mandate that has come on Thursday is arguably the best mandate which could have come?
Nilesh Shah: Yes, absolutely. This is a blue-sky scenario. This is honestly the best one could have hoped for because a few days or weeks back the spectre of government or coalition government was moving large. In a way that had cast a shadow on the market. All kinds of concerns and apprehensions were there. The good thing is that all the apprehensions have been put to rest.
For all kinds of investors, short, medium-and long-term, there is one risk which dominates from an India perspective—the political risk. The political risk died down post-2014. There was no political risk. Despite the fact that the earnings did not grow in a commensurate manner on an aggregate level, the market has done reasonably well. One of the reasons was that there was no political risk. Honestly, this mandate is the best mandates one could have hoped for. Now, it is back to growth of earnings,liquidity and reforms. It is a positive development, especially for equity investors.
Vikram Kotak: I was surprised by the numbers which the National Democratic Alliance and the Bharatiya Janata Party got. I was not expecting more than 240 for the BJP and 290-300 for the NDA as a whole. When I did the math as to what had happened,and it is very important to understand—Modi in the last five years has done the cleaning up act. Cleaning the corruption and cronyism, which was prevailing in the country, and different reforms like the goods and services tax, demonetisation,bankruptcy and Real Estate Regulatory Authority.
He has gone to the ground reality where poor,excluded people, marginal people were struggling with electricity, cylinder,not having enough water. They tried as much as possible to bring those people at the cost of urbans, taxpayers, stock market investors like us. Next five years will be the best ever because all the disruptive work has been done now. The new India has a much cleaner image than what it used to be 10-15 years back. So, it is a very exciting time for all of us.
Do some of the measures taken in the first term will bear fruit in the second term? But what does this mean for an equity investor?
Nilesh Shah: The good things about the first term of this government was that none of the reforms have been done keeping in mind that specific election or general election. Generally, that kind of approach is observed as positive. When you are a $2-trillion economy and you set out to do a bunch of things like bankruptcy code, RERA, demonetisation, GST and closure of shell companies, the impact of that was inevitable in terms of a slowdown. But still, to persist with it and pursue it, it requires very different kind of thought process.I try to relate it to what I try to do in our investing, which is a long-term orientation. This is the hallmark of the government. I go back to the 1990s and there were a lot of reforms undertaken which had an impact on economic growth. I remember that reform came about in 1991, 1992 and by 1995-96 we would feel the pain of it and the pain lasted for a very long time. It is a similar situation. The difference is that it will not take as long. We have seen the pain of it in 2017-18 and in 2019, too. Post 2019, I see positives of all of this coming into play.The GST improved compliance. It ensures that smaller enterprises go to banks and ask for the credit. Earlier the banks didn’t have the data or the data which they had was probably not reliable. GST brought transparency, credibility, a culture of compliance. From an investors point of view, the big opportunity over the next several years is to identify those kinds of businesses which are largely unorganised today but have a huge potential to be shifted to organised sector. Be it RERA, GST, demonetisation, the verdict is that businesses will have to get more organised and those who get organised and compliant will benefit disproportionately out of these reforms.
Businesses have been chalk and cheese and hope it improves materially. All of the air conditioner manufacturers, plywood manufacturers are saying that their number two market is still thriving.
Nilesh Shah: Maybe in the initial part of GST, the push on compliance has not been as much as probably it could have been. It will improve significantly. If that push towards compliance is not there, then maybe it would have not served the purpose. Our sense is you see a lot of push coming in from compliance. That will be a significant kind of aspect.
Almost everybody that we have spoken to has said that now that the mandate is here, they believe that the broader markets will gain much more than what those large valuations bubbles will. Is that your sense too?
Vikram Kotak: I had said that mid caps and small caps will underperform in the broader market because it was super expensive. The interest rates were going up. Everyone wanted to start an NBFC. A guy who doesn’t know NBFC, risk management and under-writing still wanted to start an NBFC. Everyone wanted to follow the market-cap glamour and that is what was happening at that point.
The 1991 reforms were done in a crisis. The 2017-19 reforms were not a part of any crisis. We are doing well. We still took a bold step and took these reforms. There are two different things. There is short-term pain for the long-term benefit of the country as large—I think that is recommendable. You will always do good when you are in crises, but you don’t do good otherwise and you are very relaxed as a politician. So, that is a very beautiful part of it.
In mid caps, in the last five years, most pain has come to companies which are bad in corporate governance, business model, financials, over-leverage, and promoter pledge. I don’t see any pain coming to top companies which were under-leveraged have good-quality promoters. Their market cap has gone up in the last five years whether it is in mid cap or large cap.
Lot of clean up has happened and is happening. You will see big corporates getting into trouble. It may happen. People have realised that doing business in India now is not ‘X-way’ but in ‘Y-way’.
Will it be quality versus compliance?
Vikram Kotak: Quality versus not quality is the first theme.
The quality is already priced to perfection and beyond.
Vikram Kotak: Lot of quality mid caps are subdued because of a lot of other reasons. Maybe less interest from foreign institutional investors, maybe mutual funds norms have changed so a lot of funds cannot buy small cap. Lot of PM has got stuck at a higher level, so they want to sell despite good quality. I know a lot of names which want to get out but have five-year low valuations. Now there are two parts. One is the quality versus non-quality.
Secondly, midcap as a basket is at its lowest valuation in the last 10 year. So, it is a 20 percent premium to large caps which used to be 45-60 percent. When you are expecting growth to come back, from 7 percent GDP when we start talking about going to 8-9 percent in next three years’ time, when earnings growth starts showing 20-25 percent in mid caps, what will happen to PE multiples? I think the subdued PE multiple will suddenly start looking different. My view is that the next five years are going to be super exciting for mid caps and small caps and then the large caps.
Will there be a post-election rally? If indeed Vikram’s prophecy about GDP growth moving up higher turns out to be true, then does it mean that the valuation multiple for the broader-end also spike up?
Basant Maheshwari: I think we get these things right. On a broad scale, nothing seems to have changed on the ground. It is just that things would change depending on what the government does in the next 100 days.
I get a fearful sense that this will probably be back to 2009-2014, the old grind where only 30-40 companies would do well and beyond that, there will be a handful of companies where you will have hope that this will do well but ultimately, they would not. There is a big change in the international scene which is happening. Indian market move because of liquidity. I have seen the domestic guys—they don’t push the market up. They buy at their price. It’s foreigners who buy like crazy. They will buy stocks 2-4 percent up on the same day. But the domestic guy will buy at 2-4 percent down and sell it the moment the foreigners come back. It is the FIIs which move the markets. To that extent, handful of companies will go up. The Nifty might go up, but the Nifty is a 10-stock Nifty with two Bajajs, two HDFCs and a few here and there.
So, it is not too much. I am invested in most of the sectors and it is vested interest but no recommendation. Two stocks from the Nifty and the entire sector is bleeding but the stocks are doing phenomenally well which are Titan Company Ltd. and Bajaj Finance Ltd. The jewelry market is shrinking and in NBFC you have five companies who cannot repay the old instruments, but you have one company who is taking away the market share. This is not a case where I can see something dramatic happening.
My experience tells me that when everything is going up, you need more GDP growth. You can’t have 200 stocks going up with a 6.5 percent GDP growth. We are looking at a 7.5 percent GDP growth but there are questions as to how that metric is actually 7.5 percent. So, you can tinker on the base once or twice but then the base year remains same. You cannot tinker on the same thing again and again to show higher growth. So, more than fully invested but not as excited or blindly excited but excited on those 10-20 stocks if you think you have got them and which are growing earnings at 20-25 percent.
Will we have broad-based growth? How will the markets behave if growth comes back or not?
Nilesh Shah:- I think it’s not going to be as easy to predict whether we are going to have broad-based growth or not. Right now, I think we are hopeful or more than hopeful that there will be broad-based growth. And in the context of India, what is broad-based growth?
There are four pieces in India. One is essentially the consumer piece, the other is a financial piece and the third is an investment cycle piece, and the fourth is essentially exports. That is what it is in terms of the economy, growth and the investment landscape. The consumer and financial sectors have done well. They essentially do well in an environment of a bit of sober growth. In the context of India, 7 percent is sober. India can grow at 9-10 percent. So, I think 7 percent, in that context, is still sober or moderate growth.
When will you have broad-based growth? It Is when either exports fire in a big way or the investment cycle picks up and picks up big time. Now, it has been almost 10 years that each one of us has always believed that an investment cycle will now pick up and it’s been 10 years since we have gone wrong in terms of our timings. Somedays, that is inevitable, and it is going to happen. Because what happens is, when the investment cycle picks up, then that is a very large landscape.
For example, on the consumer or financial side, what Basant pointed out, there are probably 10-15 names. Which piece you are playing on, the quality is paramount. I think you don’t want to make the mistake of 2005-07, where if you betted on infrastructure or an investment cycle piece and if you betted on the wrong names, you would have gotten washed out in that period. After 10 years today, it’s only the L&T or Thermax, ABB or Siemens which are surviving. They are not growing but they are surviving.
So, will there be broad-based growth? The answer is yes. The big question is when. And I think why we are more hopeful than what we have been than in the last few years is because you now have a government who probably in the first term has in a way come to grips in terms of overall stuff. The first term was more about that you sanitise the whole place and ensure that the business environment becomes good, fair and all of that. Now is the time for acceleration and you cannot accelerate just based on the consumer piece because there is a limit to it. It is only when the investment cycle starts firing in a big way that it touches many other aspects of the economy and probably touches a much larger piece of overall population. So, in a way the consumer cycle is good, it’s always there, it’s a structural opportunity.
The investment cycle is going to come in bursts, that you would see a period of five years when it’s going to be dramatic and then may be after that it cools off. It’s like a company doing a capex; there is going to be pain when you do capex but when you start utilising the capacity then you start seeing the benefits of that coming in. When the management starts seeing the demand going forward and then you will start getting on to the next cycle of capex. Something similar is true for the investment cycle as well.
I think a lot of mid cap, small cap are essentially in that space. Clearly, I think all that will start to fire, when you see that broad-based growth and therefore this time around, what the government announces or shows as its intent in the first budget or may be in the first hundred days, I think that will be very important.
Secondly, for that piece to fire revenue, if it wants broad-based growth, that can only happen when you have a lower cost of capital. You cannot have a situation where you want to build massive infrastructure, and you want India’s export to fire up and compete in the global marketplace when the rate of interest for an entrepreneur is 12-14 percent. It doesn’t happen. You cannot compete then with China or other nations when you are borrowing at 10-14 percent. So, clearly, I think for all of that to fire up, it’s also important that the cost of capital has to fall dramatically. It’s not like it’s not possible. Can this 10-14 percent fall to 7-9 percent? It is quite possible. If you look at the time of the earlier NDA government, 1998-2004, I think then the rate of Interest on a 10-year government security was 12-13 percent, that came down to 6-7 percent and I think now with lower inflation, and a better economy, less leakages, better productivity it is possible for the cost of capital to come down.
So, I think that, it’s contingent on two things. One is the cost of capital coming down and two is a lot of policy changes. Or a lot of intent saying this is how we are going to accelerate from here. If that is going to happen, then you will see a massive bull market in the next five years. If I say massive, it is not just about Nifty; it’s more about a broad-based bull market, in which a lot of mid caps, small caps, a lot of bottom Nifty 50 participates in a major way.
The points that all of you are making, there are two-three things impediment to each of this. One is on the cost of capital arguments. Everybody said that interest need to go down. Bankers say that the last few rate cuts have been resulted in transmission. Even the rate cuts which happen for large banks like HDFC Bank Ltd. to raise their deposit rates marginally and the entire flood of money goes to them and it is not possible for them to cut rates because they don’t get deposit holders money coming in.
Also, for the government to be able to pump the prime economy, because capex will not happen through the private sector, it has to happen through the government sector. So, for the government, to be able to do that with a stretched balance sheet, you need private strategic divestment which is not a short-term process.
Vikram Kotak: I don’t think funding is the challenge for Government of India. Look at the Delhi metro, which is fully built by the JICA, the Japanese authority, at 2 percent interest rate. There are so many multi-lateral companies waiting outside. I think the flow of capital in this country is going to be crazy. You need to identify the right project. I have seen so many big-size institutions globally like Swiss institutions to lend India $40-50 billion on infrastructure. Money is not a challenge. It is like can you show the intention, execution. I think they have executed in the past. Now is the time you will say I will double the ports, airports, bring pipe water to everyone. They wanted to build roads 60 kilometres a day as per the manifesto. If they want to achieve this then capital is not the challenge. Look at the last five years. They have managed the fiscal deficit so well. They remained at 3.3-3.6 percent range which is incredible in this environment.
The problem of transmission is the biggest problem in the economy. The guy who wants money doesn’t get the money. Those who don’t want money and sitting on cash gets the money. For some finance companies, the multiple cap is eight times and for some others it is trading half times. Same sector, same business model and everything is same.
The biggest reason why transmission is not happening is due to Infrastructure Leasing & Financial Services crisis. Post IL&FS, so much of risk aversion has happened in the system. We owned stake in auto finance company at 10 percent. They don’t get money from regular banker. So, the whole engine is broken due to IL&FS. One of the important things for the government to do when they come is to see there is a quick-fix resolution on IL&FS and even the smaller investors who are invested in bonds and FDs in IL&FS should get their money. That’s the government’s responsibility to do at least in IL&FS. I am not talking about private sector lenders because they are not accountable for it. For IL&FS, they have to sell assets, bring the money back and restore investor confidence which will also help investors to participate more in the debt and equity market.
The dangers are known and how quickly they act is the key question.
Basant Maheshwari: First you have to firefight the situation and then you have to build the building again. You have to firefight because Jet Airways is waiting to collapse. So, somebody writes a cheque then good enough. But that was held back because of elections.
For IL&FS, there has been six-seven months, but they have real assets and can be recovered. Nothing works right now. the financial market works on trust. If I know you will pay me the money, then I will give you any amount of money. If I know you might not take my call, then I will not give you anything. So, once the trust is broken, something to win the trust is to go out of the box.
Federal Reserve in 2008 said that $4 trillion put it on my balance sheet. Let me take the toxic assets. Do we have the mindset to do it? We have a government. We have a situation. We have a bureaucracy that is somewhere between capitalism and socialism. We are socialist because we have to win the elections again and we are capitalist as we want growth. So, you have to take one path, and this is how you should get out of it. You have to take one path and say let us be socialist like China or capitalist like the U.S. I don’t see media saying the RBI to give Rs 2 lakh crore in their balance sheet (to the government). You can recover it overtime, print currency. Let there be some inflation. It will be out of the box. In 2018 October, we said that NBFCs are problem. We never realised that these problems are going to translate on the bottom line of several companies. If cars are not being sold, then it is not that people are buying cars but maybe there is no so much funding. 10 percent of financial system is catered to by the NFBC space over the next five years, and we will be fine. But then the question is can the private sector banks take on the deals that NBFC has done over the last 10 years? I don’t think so.
This transition process is very difficult. Once you come off the roller coaster, you need a few minutes to stay back and say that now you can walk. We are still off the roller coaster and we are trying to walk straight.
None of you think that if the government lends more money into NBFC space then it runs the risk of putting good money behind bad money and the quality of expenditure that happens is not peak quality because it is consumer expenditure and not capital expenditure which is the need of the hour.
Basant Maheshwari: Lehman brothers failed in 2008 because they said capitalism and let the fittest survive. Sometimes you have to come out of the box and take away the problem. Rs 90,000 crore of IL&FS is irrecoverable. I have no clue how much is recoverable. But write off what they can. It gets the trust factor back. The U.S., which is the mother of capitalism, did it in 2008. In the U.S., Donald Trump got Wilbur Ross with him and entire Wall Street fraternity with him. The best thing to do is if you want to trade U.S. stocks then read Donald Trump’s tweets. If Dow is going down by 200-600 points, be sure that tweet is coming, and Dow Index will go up again. Because the ultimate objective is to get Dow high. That is why they fear about China and the U.S. but as long as Trump is there, he will triumphant Dow all the time.
So, you want Donald Trump as FM of India?
Basant Maheshwari: Anybody who can make stocks go up and make economy good is good for me.I don’t think there is debate on salvage situation. In 1990s, there was Unit Trust of India problem. It is two decades back and UTI was formal channel of savings and it was looked as savings product and not as an investment product despite being a mutual fund. But at that point of time, the government did step in and did what it did. Today it is the best investment which the government has made. The residual pieces are ITC, Axis Bank, L&T and that is one of the best wealth creators for the government. I don’t think it is to be debated so much. I think if required then one should go ahead with it.Second is, there is lot of good money put behind the bad money already. One of the reasons why cost of capital is so high is because there are so many loss-making, inefficient public-sector enterprises who are going out and borrowing thousands and lakhs of crores.In 1998-04, the world and India faced lot more challenges. There was NPA mess at that point of time. The NPA of public sector banks were like 10 percent but they were resolved. The power sector was on the verge of collapse, but it got resurrected. It is not about just time or whether you just put good money after bad money.
Vikram Kotak: Satyam was one good example. Things collapsed. People like Deepak Parekh and P Chidambaram sat in one room for eight hours and solved the problem and today it has become a blue-chip company.Second, why should the government solve the problem for NBFCs? Except IL&FS as it is semi-government. So, why should government get into this matter if some NBFC or airline is dying? It is not their business. You have taken over leverage, personal pledge, then why should government come into this area? I don’t think government needs to come here and give sops and save someone. The government won’t get anything out of it. Unless, Jet has 30,000 employees then may be the government will have socio intention and not capitalist intention that they will save it. They should not do all these things.
Ridham Desai of Morgan Stanley said he does not agree with the assessment of looking at the market from the PE multiple prism as earnings have not been linear. Therefore, look at the markets from price-to-book multiple—and therefore Indian markets are cheap.
Nilesh Shah: I think price-to-book is an outdated concept. Warren Buffett said in his annual report said book value as a concept is irrelevant. He has discontinued highlighting the book value of Berkshire Hathaway.You’ll miss out the private sector or non-banking upside if you just focused on price-to-book, say Bank of Baroda is one-time P/B and somebody else is five times P/B, so I will not invest in it. I don’t think anybody who has in the past 5-10 years focused on book value has created returns.
Basant Maheshwari: If a company with 10 times P/B dilutes 10 percent of its equity at the current market price, then it suddenly becomes five times P/B. Will you buy the stock after it has diluted equity, or will you wait for it to dilute equity? The fact that the company is not diluting equity is held against it, the fact that the company is paying dividend and reducing book value is held against it. You want the company to accumulate all the dividends and become inefficient.There is one Gayatri Mantra: It is return-on-equity and, better still, return-on-asset. If it is return-on-equity, then it is like saying all the sins are forgiven.
Vikram Kotak: It is absurd to look at P/B because we don’t know what is in the books. Today, so many companies are dying or have been in trouble for six months. They were great companies at some point of time and part of Nifty but we realised later as what was in the book.P/B has become irrelevant. A higher focus on growth is what matters. As an equity investor, we always want to focus on growth and capital growth from good capital location (and) from the promoter or company. That is where we focus on—getting the return and not at price to book.
Market currently at 40,000 Sensex. 3 years out.
Basant Maheshwari: Not more than 50 percent gross.
Vikram Kotak: I was more bullish than him, but my number was same.
Top sector to buy
Nilesh Shah: I still think it is consumer.
What theme under consumer sector?
Nilesh Shah: Tough to say. In staples, you will find things which are perhaps over-priced and staples which you probably think are under-priced. The consumer within consumer (sector) will look out for things where there is growth and where valuation is more reasonable.
Vikram, will you buy auto stocks?
Vikram Kotak: I will buy autos, but by quality lenders. I will buy cement, infra.
Infrastructure seems your big bet, Basant. Are you in favour?
Basant Maheshwari: No, I don’t understand it. We are basically two-trick ponies. So you know our stocks.
Nilesh, will you buy Infra?
Nilesh Shah: Not yet. As I said, I will probably keep some dry powder. I want to see some kind of signals that will drive infra in a significant manner—be it policy initiatives, steps to reduce cost of capital... I will probably wait for those triggers to get into the infra space.
One way to look at infra would be to look out at an efficient cement company. Because cement, in a way, is a good proxy for both infra and housing sectors. So, buy into an efficient cement company, if you don’t want to go directly into infra or housing.
Vikram Kotak: Just anecdotal data. The three infra companies in India are up 50 percent in the past three months.
Would you buy a HDFC Bank, Kotak or a DCB, Federal Bank or RBL?
Vikram Kotak: I’m a value guy. I cannot pay extremely high PE. So, I try to find out extremely high-quality management in the mid-basket.
Any high-quality NBFC names or high-quality banking names?
Basant Maheshwari: I think there is just one high-quality NBFC name.
So that or some of the banking names?
Basant Maheshwari: Private sector banks—we don’t own so we can talk about it. Axis Bank looks very good, it is changing. You have to understand that three years of earning growth gets re-rated in the first year of the companies signaling that they are changing.
So, you have to be very fast. You don’t have to get out, but the cream will be taken out in the next 12 months. Axis Bank is something like that—where if you just say that you’ll will see two more quarters, then you won’t get anything on table.
Will you buy IT? The space is bottomed out.
Nilesh Shah: Absolutely. I think IT has been one of the amazing growth stories of India, and it will remain like that. Obviously, you have to be very careful—because in IT you have companies that are growing 5-10 percent and then there are companies with 15-20 percent growth. I am a big believer of IT and I think it’s a fantastic opportunity.