India Inc., Not Government, Will Have To Drive Growth This Year, Says Kenneth Andrade
Indian companies will have to “stimulate growth” this year as newly elected regimes typically take six to nine months to kick off major spending, according to Old Bridge Capital Management’s Founder Kenneth Andrade.
“I don’t think you will see big-bang spending from any government that comes to power,” Andrade told BloombergQuint. “The year following the election is usually a year when the government actually consolidates its balance sheet.”
Companies need to complete their previously accumulated heavy orders, including those from the government, in order to drive growth, he said.
That’s when multiple indicators point to a cooling economy. India’s GDP growth slowed in the quarter ended December amid a credit crunch and easing demand. Industrial output has also fallen since November and manufacturing growth momentum, reflected by Nikkei India Manufacturing Purchasing Managers' Index, slowed to a six-month low in March. And automakers are battling an extended slowdown since September last year.
Still, Andrade expects 2019 to be a year “with fairly even yield”. “You will have growth and continuation of what we saw in last two quarters,” he said.
Watch the full interview here:
Here’s the edited transcript:
You said that polarisations don’t last. Do you believe there is a bit of polarisation in terms of valuations or are you comfortable right now?
In the first quarter, the breadth of the market bounced back. We had a disaster of 2018 and it continue to January and February of 2019. March was revival of where valuations or stocks bounced back. Polarisation continues to happen. You are getting it in a couple of segments and that’s the nature of market because money continues to chase the outperformers for some time till it actually stops. Then you turn to finding opportunities that exist in the cycle.
In 2017, it was all about mid caps and in 2018 it was all about large caps. 2019 seems to be fairly even yield. Within that if you break it down, it’s 3-4 companies and one sector of market which is consistently outperforming markets and benchmarks. That’s the nature of environment and it will continue on for some period of time. But the rest of market won’t be left behind.
Would it be a factor of how 2019 started? Are we now at a good place when it comes to prices?
In terms of prices of where they are, I think they are at a fair level. I don’t think you’ll get too many bargain discounts currently in environment that we are setting in. They were available at beginning of year, but I don’t think today you will get big discounts which keeps the focus back on earnings season. If you continue to deliver what we did in the last two quarters, which I don’t see any problem repeating itself in rest of calendar or financial year. We should be okay in terms of where the markets are placed.
So, valuations aren’t at a steep discount. Balance sheets are okay and good. Whatever clean up which has to be done on banking side has also been done. Corporate India is one the best places to be in globally as far as growth is concerned. You got capacity on ground, you’re optimising capacity and delivering profitability.
You mentioned that 2019 and better part of FY20 could be period of bottom line growth outstripping revenue growth because costs are lower and utilisation moves up. Do you think it will start from the current quarter?
We’re seeing that happen. We’re seeing pricing power emerging in some segments and margins are picking up. There has been no addition to significant amount of new capex on ground. So, all of this will contribute to profit and capacity utilisation.
As a large portfolio manager, does your investing strategy change if the regime at centre changes?
The year following the elections is usually a year when governments consolidate their balance sheet because they overdraw the future into them. This year we will probably see them consolidating their business. I don’t think you will see big-bang spend from any government that comes into power. Either of governments coming into power (NDA- or UPA-led) will have at least 6-9-month window before they can action anything which is there on ground.
So, it’s left for corporate India or companies on the ground to do best on how they can stimulate the environment. For companies that address government spends, there’s enough of more work to finish off that they have accumulated in past. Their order books are very high. They will have to take it forward and they have got enough and more on their table to drive growth into 2019.
From consumer part of the market, that market is repairing itself after what we saw following the collapse of non-banking lenders last year. That will repair itself. That could remain as the weak part of the entire cycle. Also, you have to wait for monsoons. That will have a relatively low impact on consumer spends because balance sheet of the government in that economy is far larger than what it was historically. I don’t think there could be a large rural slowdown. So 2019 is going to end up as a year with fairly even yield. You will have growth and continuation of what we saw in last two quarters but nothing significant from any new regime which comes in.
2018 was the year of portfolio corrections. In 2019, the levels we’re sitting at on the cusp of earning season which might deliver, is it time to hold on to the investments and convictions that we have as opposed to making large-scale corrections?
We’re already over and done with it. I think we have got back into a cycle where you can’t dramatically overhaul full portfolios right now. You usually do that when markets are trending downwards. So, you can swap out of a business to buy a relatively cheaper business at that point in time. Today there’s reasonable amount of momentum in the cycle for you to take those big changes on large portfolios. For small portfolios, you can move them around. But for larger portfolios, you won’t be able to do it. A large part of these changes should have already happened. It depends on positioning and the conditions over the next couple of years. And portfolios will be in line with that part of markets.
What’s the big elephant in the room that could impact markets? What alters your conviction?
We have seen in the past that we need growth and valuation at your side. When growth picks up, valuation moves and that’s how you compound capital because you have two levers. We have been careful to not allocate capital to any business which is sitting on high valuations because you tend to have only one lever which is growth coming in. For us as portfolio managers, we find it extremely difficult to predict growth year after year. So, we need to have valuations on our side. Those are two elements where we tried to put the portfolio together.
If I have to alter my convictions on market cycles, sectoral valuations have to get very expensive as a whole and they’re not in that zone. You find, sector wise, some parts of the markets that are cheap. That’s how we try to put it together. There are pockets of opportunity. There are also pockets of opportunities where we find there is no reasonable value on those companies and we are happy to stay out.
Do you look at market-wide valuations? When people talk about 19-21 times depending on your estimates of Sensex P/E multiples, do they bother you when you deploy fresh cash to work or when you are taking a call to sit on cash?
Yes. Any market which is extremely elevated irrespective of what you have in your portfolio will correct if the markets correct. One should deploy cash into market opportunities which probably haven’t participated in the past. In 2007, it was commodities and infrastructure which gave way to consumers, financial services, pharma in 2015. Everyone was very optimistic on how India will build infrastructure in 2007 to 2011 and none of it happened. But the value part of market emerged, and they also kicked in with element of growth which came through. From pharma perspective in 2015, it was peak of entire cycle and everyone was optimistic on how pharma businesses can evolve into 2020 and that was trading at expensive valuation. Slight hiccups—on the regulatory side, and pricing power, which collapsed—and that part of the market gave way.
Nothing stays secular in perpetuity. You will need to watch market cycles. Try to participate in those markets where you have valuations on your side because that is normally ignored. When you get that part of market all you want is for the cycle to kick back. Every business is cyclical in nature. There is no business which is gone out. You have disruptions which come in. Once the cycle kicks back and it comes with huge consolidation and that market emerges.
When you look at market-wide valuations, it’s usually driven by couple of segments of market which drive market valuations to where they are. That is in everyone’s portfolio or it is large component of index. So, you are watchful of those parts of markets. If we’re fairly convinced, then we’re okay participating in it. But we will rather look at other side and see where we find both opportunities both from valuation standpoint, which is at cyclical low, capacity going out of system and waiting for business to bounce back.
Would you question the permabulls in staple space?
They define staples as a secular business and they have been secular for a long period of time. You go back in time and see cycles playing out in staples. FMCG businesses in India are the most expensive globally. There was a time when they were available at fair amount of discount. I’m sure there is growth in India. We have got 1.3 billion people consuming everything. I will be a little cautious in saying that India is large market and everyone consumes something. I will be cautious on that part of business.
Where do we find opportunities where the cycle might be just turning around, or valuations are in your favour?
If you have to find high quality companies, you have to find it in businesses that are doing badly. That’s where the valuations meet. That’s why you have to wait for cycle to play out. You look around, you will find them everywhere. You do a round of all the businesses in pharmaceuticals. They were nowhere close to previous highs. Their business is static or growing larger and you can find then right through the categories from larger companies and smaller companies that there is. I won’t say there is lot of value but there is reasonable amount of optimism and utilisation which is low in that part of world.
You look from entire infrastructure space from contracting, utilities, capital good manufacturers.You find reasonable opportunities from there. You have seen big corporate banks play through this cycle. They have done fair bit from last quarter. They hit 52 weeks lower. On a nine-year basis, they have given less than single-digit returns. They have come back in one quarter. If you put these pockets together you will find very large number industries offering you reasonable amount of value on ground.
The automobile sector seems to have hit a rough patch. After three months, the auto numbers (financials) are starting to look wobbly. Is this a short cycle which will get corrected soon because there is so much auto demand in the country? Would you believe that it’s difficult to predict even in a story which is seemingly as secular as autos?
Not long ago Maruti was trading at 10 times its earnings. Today the transition in leadership, growth, distribution has created a large company in terms of market capitalisation. If you look at the entire value chain from finance company to auto company to a consumer, the biggest part of profit pool is still captured by the financier, especially in an environment where the market is fractured so dramatically. You could have ten guys competing for same customer. You might still get volume but my sense with profitability will reside with finance businesses or with the guy who actually finances the car. So, that chain has to be integrated as where you want to capture value and profit pool. That market is almost 80 percent finance if not higher. So, you need capital flow coming in to build distribution. Private sector banks will step in into that part of the world and they will grow their books. Over a period of time, affordability should also come through. Affordability of not just the car but to service the vehicle loan. I will reserve my optimism for that segment for some time still.
When you hit a slowdown usually it lasts for couple of years and if not years, definitely a couple of quarters. You need stabilisation, introduction of new products, you need to find pricing power, you need product launches and most importantly you need lower competition. You have got a large event coming up in terms of transition to BS VI (emissions standards) and that will be an expensive proposition for a lot of consumers. There are too many moving parts in that sector. All of those moving parts will slow the environment for some time.
Are you on margins turning selectively optimistic/ bullish on any segment in financial space?
We saw some of corporate banks bottom out and that was a nice environment. Corporate banks and infrastructure businesses are bottoming out—you could choose between the two. I always prefer asset side of the business because some of them would be free cash flow business and you get that in capital goods. In financial services, you never get them. In infrastructure, contracting and construction you don’t get free cash flow businesses. So, we play on asset side rather than playing on liability side. We have maintained that line. If one does well then other one has to do well.
Sometime the pricing is at one end and the sometime at the other end. So, we like it on asset side. We continue to put most of the portfolio out there. It’s not that we don’t have a view on financials. Any financials that are expensive, or trade beyond what we can afford to pay, quite clearly sides them.
If we had El Nino or deficit monsoon, do you think government will take care of businesses there?
We have moved beyond the monsoons. If we have a good monsoon, then it creates more demand. So, demand will be where it was. The government stepping in, it will continue to be where it was. If we have a good monsoon then it changes the trajectory. So, the downsides are capped.
What about global picture?
That’s an iffy kind of a market because the world’s largest economy (U.S.) is also slowing down. The largest economy in emerging markets (China) is also slowing down. Whole environment is moving to a low growth plane. Exports are going to be reasonably challenging.
Is there risk coming from outside in capital markets?
A slowing global economy leads to a loose monetary policy which we have seen from the last 15 years of data. That should keep the environment relatively stable. It will not kickstart global growth all over again, but you will have demand for more financial assets and to a level some hard assets on the ground.
If slowing global economy doesn’t get arrested by fiscal or monetary policy, would that be a threat for India which is expected to grow at 7-odd percent?
I don’t think global economy will slow down. Everyone is pegging it to a lower level of growth.
Will the market behave differently if global economy slows?
How much will you value market? That’s been a question which I don’t think people have come up with answers from 2017 to 2020. First you had an environment where rates were going up which meant that price on multiple has to come down. If rates are stabilised and go where they are then markets found its mean in 17-19 times earnings if downsides are capped. If rates come off and growth comes down, you will tear up slightly in terms of valuations. Markets might behave little differently but not dramatically differently from the economy.