Madhusudan Kela On Covid, Yield Scare, PSU And New-Age Businesses
Two factors are likely to contribute to a rise in inflation that could ultimately hurt markets, according to veteran fund manager and investment adviser Madhusudan Kela. Some of the world’s biggest economies are faring much better as they have managed to contain the pandemic because of lockdowns and a higher vaccination rate. And the system is flushed with liquidity.
But that threat is still some time away, Kela, founder of MK Ventures, said in BloombergQuint’s special series Navigating Through Uncertainty. Before higher interest rates will hit global markets, the positive rub-off of an economic revival is going to play out in 2022, he said. “I don’t see that global markets are going to collapse.”
Here’s what Kela said on the global economy, inflation, India and key themes:
Will rising yields cause a market collapse?
Globally, there is a positive tailwind for economic growth because of opening up and the base effect of 2020, according to Kela. Every government and every central bank would do their best to ensure that the revival is not disrupted and the asset price increase, something that is going to pull economies out of the dangers of recession, is not disrupted, he said.
There could be a bit of reallocation from debt to equity if benchmark bond yields move up, but Kela doesn’t see markets collapsing due to yield movements.
Will Indian markets correct due to Covid second wave?
That phenomenon is already visible to some extent, Kela said. “If you look at the Indian market, it has been underperforming.”
“Forget the broad indices, there has been a much deeper correction in a lot of stocks which are essentially linked to the economy and which have had a good run in the first quarter, between January and March,” he said.
The outflow of more Rs 10,000 crore worth of foreign money in April is not in line with what is happening in other emerging markets as they are seeing inflows, he said.
Whether the market falls more or if there will be a full lockdown, Kela said he “would not assign 0% probability to any of that because no one knows how this virus is going to mutate and what are the resources which India or the world has to combat mutations”.
But he is hopeful of a solution now that the entire machinery of the government is behind the problem and the world has come to India’s rescue, he said. Kela, however, dismissed the notion that there will be a repeat of 2020 because the markets are now prepared, as are the medical facilities and corporations.
Which businesses will do well in India?
The bigger and well-managed companies will get bigger, a reason the valuations they are getting are justified, Kela said. Most of the large companies are gaining market share at the cost of smaller and unorganised players, he said.
Kela is also bullish on public sector firms as he expects divestments to pick up since the government needs resources. He hopes that at least two to four state-owned companies including Bharat Petroleum Corp., Container Corp., Shipping Corp. and Air India are privatised this fiscal.
“We studied the whole Margaret Thatcher era of the U.K. when the disinvestment actually happened. From 1978 to 1982, the GDP growth rate of the U.K. was negative. When the entire programme got unveiled for the next 10 years, there was a 5% plus growth. All these companies (that were privatised) include British Petroleum, British Airways. They got new shareholders and new management.”
Kela said it’s very much possible that India can have her version of the Margaret Thatcher moment. Kela expects this to playout for the next five years, if India goes ahead with privatisation.
There’s also “absolute disbelief” about a rebound in PSU banks but divestment will be a game-changer, according to Kela. These banks are still trading at 0.5-0.6 times even as they have provided for bad loans.
They have made provisions worth Rs 11 lakh crore or roughly 10%-12% of the total advances. “They have done their neighbour’s provision too,” Kela said, underscoring the reason behind his optimism.
How should investors approach new-age businesses?
While new-age businesses are not cheap, they have compelling business models. But such companies will not make a lot of sense to a traditional investor like him who always want to buy cheap, he said.
Kela, however, said that he has learnt in the last two years that what “is valuable, you have to pay that value for it”. Still, he doesn’t see the necessity of owning such businesses because, eventually, every investment has to make sense on valuation metrics, he said.
He cited the example of Zoom which is trading at 30 times its revenue. Someone like him can never buy it even after knowing that it may make money, Kela said, advising investors to be very calibrated in their approach.
Watch the full interview here:
Here are the edited excerpts from the interview:
I know that these are really tough times for our nation on the humanitarian front, but it is because of that crisis that the investing world is also thrown into a dilemma about whether we will see a repeat of what we saw in 2020, not on the humanitarian front but on the economic front and the equities front, or do you think that because the globe is in a slightly better place, and because we are in the midst of a vaccination drive, we can probably do that better? Let’s start off with the globe, what are your thoughts there because everybody talks about geopolitics, rising interest rates, or rising yields and the kind of challenges that these two things, pose. What are your thoughts here?
MADHUSUDHAN KELA: What I would say is, globally, I think from a pandemic perspective to look at the largest nations and the most developed nations like the U.S., the U.K. and parts of Europe and Japan, I think a lot of these countries have done a very good job and a significant portion of their population is already vaccinated too. If you see, they had locked down the country for a significant period of time, like U.K. literally had locked down the whole country for more than a year since the pandemic started, more or less. So, I think they are definitely in a much better position vis-à-vis the humanitarian ground is concerned. Then you come to markets, there is still so much liquidity in the overall system that there are chances of inflation coming back and hitting the market very significantly.
To my mind, we are maybe still some time away from that. How much time, that I can’t put, but we’re still some time away. I don’t see that as an immediate threat right now. What we are globally looking for a positive tailwind worldwide is because 2021 was a very dull year, in terms of economic growth as most of the nations had begun their GDP growth rate. So, a revival of that is what we’re looking at. You saw the first quarter GDP of China growing by 18%. I think before the interest rate will hit global, this positive news is going to play out most probably in 2022 of the economic revival. So that’s how I look at it. I don’t see that global markets are going to collapse to put it more precisely and bluntly.
I heard you mention that you don’t foresee the yields or the rates to be an immediate threat. Am I to assume that you believe that, therefore your current conclusion or the current thought process is even if the yields were to move up, they’ll move up gradually and therefore not pose a challenge to the current hypothesis?
MADHUSUDHAN KELA: That is what my current thought process is because every government and every central bank would do their best and this is what they’ve been doing to ensure that the economic revival is not disrupted. This asset price increase which is happening the world which is what is going to take us out of this recession, is not disrupted. I don’t see that as a big problem. So, yields move up, there is a little bit of reallocation from debt to equity—all of that will happen, but are we looking for this to be the threat that everyone would be talking about in the next six months and markets would collapse because of this? I don’t think so.
Does geopolitics worry you? There is this formation of the quad versus China so to say, Iran today has come out and said there is a very productive meeting that they had for coming out of the sanctions that they have been in and that might create some bit of issues in the Middle East. India versus Pakistan what have you, is that even in the realm of possibilities of causing any havoc or you think that it will pass?
MADHUSUDHAN KELA: Again, people have very different theories. One thing which I believe that a lot of the people in the world believe, is that this problem got accentuated because of China and with the virus, there are all kinds of conspiracy theories which going around but I’m not an expert on that subject remotely so. I generally feel that in the medium to long term, that once things settle down, then how the realignments will happen and what will the partnership be of China vis-à-vis other countries, once things settle down.
That will be one big thing to watch for and that is what I will watch for because there would be a lot of cases, that could be very beneficial to India. Let’s take for instance a sector like steel, where the prices have gone through the roof and even Indian steel companies are really benefiting because they are able to export and it is because the economic revival in China is very strong and they are also cutting down on all kinds of export incentives that they put—like what we saw in speciality chemicals and in API for instance. So, this small shift away from China could mean 100% growth for India. I’ll give you a small example of what I’m meaning. Let’s say India exports $5 billion worth of API, China does $50 billion. If you have a 10% decline there and that shifts to India, then on paper, we can have 100% growth. It’s not that we don’t have the capacity, but that’s the kind of swing, which we are talking about. So, if you can take this presumption from me that, that is a distinct possibility in the medium term that the world realises and they either want to have a second source, which will clearly in some cases be India or there is some kind of a realignment overall in the context of China.
A quick follow up but with the earlier part of the conversation, if the world isn’t going to collapse because some parts of the major economies are largely getting vaccinated, and so on so forth and the growth numbers are coming back. Do you sense that because of our own idiosyncratic problems in India, largely around the lack of vaccination in the way that we should have had, so to say and the current lockdowns—the CII said even a limited period national lockdown is not unwarranted to reduce the misery. Do you reckon that in the relative context in the near term, India could be left a bit behind, simply because we are dealing with these stresses currently?
MADHUSUDHAN KELA: To some extent it is already visible. If you look at the Indian market it has been underperforming. Forget the broad indices, there has been a much deeper correction in a lot of stocks which are essentially linked to the economy and which have had a good run in the first quarter, between January and March. Then in the month of April we saw more than 10,000 crore rupees of outflow from India from a foreigner’s perspective, which is not in line with what is happening to other emerging markets but because emerging markets are still seeing inflows. What I’m saying is, to some extent, it is already happening. Now, whether it can accentuate or whether it will become far deeper or whether we are going to have a lockdown—those are all probabilities. So, I would not assign a 0% probability to any of that because we don’t know how this virus is going to mutate, what are the resources which we have, actually, if the situation becomes really challenging. We have seen that at the end of the day the final solution is to stop movement, and that is when you can stop the spreading, so I wouldn’t assign 0% probability to anything of what you have said, but I’m quite hopeful that the entire machinery of the government is now on work 100% I would say, the whole world has come to the rescue of India, so you will have a lot of aid which is coming from India. One important thing is, most of the Indian problem, if you see is all around, oxygen, it is basically what is happening in the North or what is happening in Delhi. Now Reliance has put up a 11-hundred tonne oxygen plant in three weeks. So, if you really want to put up an oxygen facility, it should be possible, like in the next two, three weeks and hopefully this oxygen problem should resolve. So, my heart goes and trust me I’m not doing anything for the last eight days but I was trying to help as many people as possible and I’m glad that I could do my little bit. It’s just very distressful to see it. Forget the market and the economy but it very distressful to see people dying because of lack of oxygen and my sympathy is for the people who have died and for the entire family.
The question is this, I hear a lot of people correlate the current situation to 2020, and everybody says that in 2020, didn’t you see that the markets looked ahead and we recovered, or the day that we imposed a lockdown was the day of the bottom and then we recovered. But the point that I want to understand then from you that when that happened, we were at 7,500 at valuations which were much cheaper than the 20 to 23 times multiples that we are trading at currently. Would you reckon that if we were to, for the right reasons have extensions or if not lockdowns then restraining measures, is there a legitimate or is there a necessity for the market multiples to come off a little bit from where they are currently?
MADHUSUDHAN KELA: Let me make a few points. First of all, when it happened for the first time, we were completely unprepared. There were no vaccines, there was very little awareness about treating the Coronavirus, there was very little awareness about the medical community also. So, the extended and the nationwide lockdown for six weeks was a necessity to create medical infrastructure. It was the right thing to do at that time and obviously the markets were unprepared. I do not think any of those situations are going to get repeated, we are not going to have a 50% correction in the index like what happened the last time from 12,500 to 7,500. I’m not in that camp at all. We are medically, in a very good situation to deal with all of it and overall, we’re in a much better situation. Third, I think that companies are much better prepared. The companies were caught by a surprise and there was complete uncertainty. So, in the first phase, it was not clear if we’re only going to last for six months or six years, we could have made a case that it will last for six years, because if the vaccine had not come then anything could have happened, but now we have the medicines, we have the treatment, we know how to treat people and companies have learnt how to tackle this problem. So, assume that even if there was a lockdown there will be a correction in the market, but I don’t think it will be anywhere near to what happened in the first phase. Again, my sympathies and prayers for the people who are suffering because of this but if that correction were to happen again it will be a buying opportunity.
2020 showed us that some of the sectors and some of the industries were able to cope with these supply chain issues a lot better. Some of them actually became much larger on the global footprint because of the China plus one narrative that you spoke about as well. And in some cases because of the reliability of earnings, the multiples went up quite substantially. From where we are right now, where do you believe that themes have the possibilities of doing much better on the business front? Forget what happens to stocks but can you just tell me where you see business growth and momentum really looking sharp because of either inherent factors or global factors working in India’s favour?
MADHUSUDHAN KELA: One thing that is very clear in my mind is bigger companies and well-managed companies will get bigger. It’s because of that reason that the valuation they are getting is not an unjustified total. So, you look at any company in any sector, they are gaining market share at the cost of the smaller players and they’re gaining market share at the cost of the unorganised players. That is one thing that is very clear. Second, I’ve been very loud in saying this, and its gone all over that I’m quite bullish on the public sector theme because I personally feel that this time, the disinvestment will be for real and also the way that the government also needs resources today. Why do you create assets? You create assets so that you can sell it at the time of your need. So, this is the time for India to need people around. I think the disinvestment story is for real. I would like to watch at least two or four companies getting disinvested in this year, including BPCL, Container Corporation, Shipping Corporation and Air India, which are being spoken about. I’ll just take you back a little bit. So, we studied the whole Margaret Thatcher era of the U.K. when the disinvestment actually happened.
In 1978 to 1982, the GDP growth rate of the U.K. was in the negative. When the entire programme got unveiled for the next 10 years, there was a 5% plus GDP growth rate. All these companies are British Petroleum, British Airways, a lot of these companies actually got reversed and were privatised. They got new shareholders and a new management. What Mr. Modi spoke of four months back, and he has a track record of doing what he actually speaks in pubic, whatever it may be. What he spoke about was, we are going to privatise 100 companies. Now it could be units or companies, but it is still massive. So, is it India’s time of Margaret Thatcher kind of disinvestment? So, will it unleash a lot of value? Will it unleash a lot of potential? Will it unleash even the economic growth in India? So, I am in that camp, who believes that it is very much possible and am tracking this very closely. You know that we are in a democratic setup, it is not very easy to do anything that you want to do. So that’s why I’m saying, I’m still watching it. If this thing were to play out, I think this is a huge theme and it will play out for the next five years.
And most of these companies are leaders, right? Be it BPCL, Concor, SCI all of them are leaders in their space.
MADHUSUDHAN KELA: Yes, they are leaders but not as well managed as the private enterprises. So, they have are a huge leverage to cut cost and to leverage to explain bigness. So, the public sector needs to sympathise with them because if you take 100 decisions, you are expected to be right in all 100 of them.
In the same vein, can I ask you, there is again in the same theory that the thought process floating around that even in the case of some of the PSU banks, they will be significant private interest because there’s a ready-made infrastructure for any aspiring bank or any aspiring NBFC to come in and just grab that network?
MADHUSUDHAN KELA: In the public sector space, I’m the most bullish on public sector banks because if you see, in the last six years from 2015, the clean-up started. I’ll give you some numbers. In the last six years—about five years and nine months for the period in which the results are declared, you’ve made roughly 9,85,000 crore rupees of operating profit for the 27 public sector banks which were in existence from there. You’ve made 11 lakh crore rupees of provisions. Rs 11 lakh crore which is roughly 10%-12% of the total advances of the banks. Third, you raised 3,40,000 crore rupees of new money for these public sector banks. I am telling you that they have done their neighbour’s provision too. There is absolute disbelief in the ground that these banks are going to come back. The number has gone from 27 to 12 after the consolidation.
If they are divested, then we will be left with eight public sector banks. A lot of these banks are still trading at 0.5-0.6 times the book value and they are generating 1,50,000 crore rupees collectively of operating profit from every year. Their provision coverage ratio is ranging between 75-85%. So, their adjusted book value is close to what the book value is of what is being reflected. I think there is huge value which the market will, at some point of time, recognise and when the economic revival happens in India we might be delayed by one quarter, but you just imagine that kind of pricing power that some of these banks will get. All put together, there will be only 12-15 banks in India, including the private banks who can take a call. So, I’m actually quite positive and if two of these public sector banks which are being spoken to be divested, if that happens, then that will be a huge trigger for the revaluation of the rest of the lot.
Since you have deep thoughts, I have a follow up question here. There is a thesis that I’ve heard, and the thesis is that the next decade, the reverse could happen wherein PSU banks because of the formation of the bad bank, and the corporate loan accounts which they were anyway not being able to do well are parked there and they are in the retail lending with the branch network that they have, could actually gain market share compared to the last three decades of losing market share. Do you think that can happen?
MADHUSUDHAN KELA: I am not yet betting on that. I am betting on that these banks will become very cheap. For me, first let it come to a reasonable value. Once it goes to a reasonable value then we’ll debate what the prospects are, what kind of growth they can get, what kind of markets they can gain or not. The other thing, which I want to highlight in case if we miss it. The last 10 years was all about governance, high ROEs, free cash flows and very asset-like businesses. So, a lot of my colleagues and peers and people I speak to— in the last 30 years of my learning, you tend to extrapolate your own success. So people who invested in these companies and if they have gone to absolutely very rich valuations and you pick up any company of that lot, you can’t justify their valuation as compared with the growth which they have in most of these cases. So, my conviction is that, the next five seven years may be different, maybe we are already moving towards value, maybe we are already moving towards stocks and sectors which will benefit out of the cyclical uptrend which we’ve forgotten, like PSU banks, and like what happened in Metals. The metal index in the last one year has gone up by 150-200%, and so many companies have gone up 200-400%, if you look at the real and genuine portfolio of large investors, you will not find any significant exposure to metal stocks even three months back. I think the more the needle moves in this direction, it could result in a 100-200% price hike in a lot of these stocks and sectors.
Where do you think there is this mispricing? PSU banks and PSUs are one thing. Do you think that power or infrastructure are some of the themes?
MADHUSUDHAN KELA: I am saying the entire economy pack which is to likely benefit out of the cyclical upturn. Sometime ago, I did the entire market capitalisation of all EPC companies put together and again, I went public. It was only 50,000 crore. With only 50,000 crore, you could get the entire EPC basket, 25 companies all put together except Larsen & Toubro.
But it’s tricky, the space? Sure you with your arsenal and your experience can separate the wheat from the chaff, otherwise there will be only one or two winners out there especially in the EPC space. Metals are different because they are large companies.
MADHUSUDHAN KELA: My friend, you know that making money is always tricky. If you are going to do it on your own, you have to know the trick. That is where the big returns are.
Can I just ask a quick follow up that while the juice may be in these themes which are undervalued currently and might gain but the companies that are select themes which have done very well in the last two or three years maybe, but are talking about tremendous business growth opportunities for the next four or five, do you reckon that they could continue to better as well? Specialty chemicals is one, you mentioned APIs and if you talk to any API company, they are talking about business growth and targets being tremendous for the next two or three or five years.
MADHUSUDHAN KELA: Some of them will continue to do really well. What I meant was, for only companies where you have an exceptionally high valuation and low growth. So those are the companies you have to rethink of. Even those have to be a falling part of your portfolio, if you are constructing a portfolio, you cannot have zero FMCG allocation—if you’re an institutional investor or otherwise. So, what I’m saying here is, that this is a theme which might be likely to get momentum. That doesn’t mean that the other companies or other sectors will not do well. I think this will be my preferred choice for investing incrementally.
Anything that surprised you in the last three months or anything that made you think that oh my god, I didn’t foresee this to happen, but it did happen on the business front?
MADHUSUDHAN KELA: The whole resurgence of the virus. That is also surprising, but you have chosen a very interesting subject. Let us assume, in my opinion, life is going to be uncertain and very volatile. We don’t know how many more new mutants this virus is going to have. We don’t know what kind of a geopolitical world we are going to live in. We have to be able to adapt to all of this while investing. We have to make volatility as our friend and not consider it as a risk. Only when you have that kind of a mindset that you can live with the volatility and you can distinguish what the difference between risk is and volatility is, then will you be able to have investments which are made in distressed times and then only you can make some sizable gains.
I remember coming to your office a couple of years back in the good times, and you had spoken about how you’ve taken a very keen interest in the non-listed space, in the private space and you’re wanting to really multiply your investments there. Then, I was hearing with keen interest, your interaction with Rakesh Jhunjhunwala at the time where you and him spoke extensively about the unlisted space as well. 2021 is being considered by many to be the year of IPOs—which we have not seen before. Can you share some thoughts here?
MADHUSUDHAN KELA: I think we do it and now, as a family we do it. My nephew is very young, a 30-year-old, and he looks after more after these new-age investments and the new economy. So, we do it only from the family office and with the family money, but we have done quite a few of them and we continue to pursue and look for them.
What I meant was, there are a bunch of these new age businesses coming to the fore. If we had Nazara in the gaming space, we will have a NSE listing and therefore exchanges will become a large platform, a bunch of other companies like Zomato for example, are coming up. Which of these new themes interest you? I’m not asking where you’re investing in.
MADHUSUDHAN KELA: I think that in a lot of these companies will be very interesting companies to look at because they will not look cheap. They will not make a lot of sense to a traditional investor like me, who always wants to buy cheap but I have also learned in the last two years that what is valuable, you have to you have to pay the value for it but at the same time, let’s not get overly worked out that I have to own this. Finally, it has to make sense in some metrics too. So, what is happening internationally to a company like Zoom Telecom worldwide? If it is trading at 30 times revenue, someone like me, can never buy it even after knowing that it may make money. So, you have to pursue a particular style. I would say that there will be a lot of good companies which will get listed, there will be a lot of opportunities, but you have to be very calibrated on what you want to pursue. Someone like me will still look for a value within that basket vis-à-vis what the growth is, not an absolute P/E multiple, but vis-à-vis what growth the company can promise and what is the valuation which I’m keeping and there will still be opportunities to make money there.
Any conversations with corporate India which make you believe that the economic recovery that we are hoping for, for a really long time, will finally come to fruition in this year? Some of the companies that I’m speaking to are sounding very optimistic never mind this quarter one issues surrounding lockdowns and Covid.
MADHUSUDHAN KELA: Before we get to the answer of this let me just put a disclaimer. Here, we have spoken very extensively about sectors, companies so people who are watching they need to do their homework and consult whoever they need to. I would say the economic revival was already happening. If you see the January-March quarter, it was stellar for a lot of sectors and we could actually see things happening in the ground, whether it was cement, whether it was steel or infrastructure or power. The things were already moving. I think if this thing comes under control which is what my base case is, that this will come under control in the next one or two months, then I think the momentum will continue because among all of this, I think the best job is being done by the Reserve Bank of India. They have unleashed so much liquidity and there have been so much on the ball all the time to address problems of the entire economy as much as they can so that has not gone away. Now, let’s hope and pray that this wave two comes under control and we are again going to see good times all over again and soon but this quarter, I think will be definitely quite challenging according to me.