Stock Market Unpredictable, But India's Long-Term Story Still Intact, Says Nilesh Shah
Kotak Mahindra Asset Management Co.’s Nilesh Shah has said Indian stock market's long-term growth story is still intact even as uncertainties around Covid-19 and an earlier-than-expected taper by the U.S. Federal Reserve loom.
"It's impossible to predict how the markets will behave but we want to reassure investors that the longer-term growth story is still intact," the group president and managing director at the fund house told BloombergQuint’s Niraj Shah in an interview.
"Corrections are a part and parcel of any market," he said. "But within small- and mid-cap you can pick up the right stocks which are showing tremendous growth opportunities because of a variety of themes."
There are several investment themes that have emerged from India's performance-linked incentive (PLI) scheme, he said. “There are medium to longer term trends, and investors will find many market out-performers in this spectrum.”
PLI scheme has offered “great opportunities” in electricals, electronics, textiles, and mobile handset manufacturing. Further, when the auto, auto-component policy is announced it will create another opportunity for investors, he said.
Industrials and engineering companies, which were in a tight spot over the last five years due to low volumes and utilisation, have "improved their processes and cut costs", he said. "Their order book is expanding in the local as well as global market, their operating leverage will kick in and they will be able to generate a very decent profitability growth, way above market average."
Investors can also benefit by looking at companies that are likely to benefit from a manufacturing shift away from China, Shah said. "People are actively seeking quality Indian suppliers and if we can capture this opportunity over the next four or five years, it can really support India in narrowing the gap with China."
The Taper Impact
Central bankers globally have pumped liquidity and kept interest rates low to support growth during the Coronavirus pandemic. That is likely to change as with central banks now contemplating about the right time to roll back their emergency policies.
“We believe they will do the reversal in a calibrated and a gradual manner, so as not to disrupt the apple-cart,” Shah said.
However, he doesn't expect as much as a reaction to the previous taper tantrum. "In 2013 taper tantrum announcements created more disruption in the market than the actual withdrawal of taper tantrum," Shah said. "This time, smart investors will not give as much reaction to taper tantrum as they'd given in 2013."
Shah is confident that the Reserve Bank of India will manage any potential transition to pre-pandemic policies well. "RBI right now is in a pro-growth stance, and they will take an appropriate action in any way. Over the next four or five months barring the spike in onion and potato price, inflation should remain within the RBI’s higher end of the comfort zone."
Watch the full interview with Kotak AMC’s Nilesh Shah here.
Here are the edited excerpts:
Just one quick word because there's so much happening on the rates, on the taper and what will happen in India with regards to inflation and interest rates, etc. Can you summarise all of that in an answer and then we'll move on to the capex conversation? How do you view all of those pieces?
Nilesh Shah: Globally, central bankers have pumped liquidity, kept interest rates low to support growth and obviously at some point of time that had to reverse but we believe they will do the reversal in a calibrated and a gradual manner, so as not to disrupt the applecart. If we see liquidities flow, creating excess valuation NEFTs, Cryptos and unlisted equity comes way ahead of listed equity. More importantly, in 2013 taper tantrum announcements created more disruption in the market than the actual withdrawal of taper tantrum and hence this time, smart investors will not give as much reaction to taper tantrum as they'd given in 2013. In India, RBI has done an excellent job in managing multiple objectives. They have absorbed hundreds of billion dollar flows in the last 18 months, kept the rupee still stable. They have ensured massive borrowing program of the government goes through and still, interest rate sustainable. They have ensured that excess liquidity built up in the system does not translate into runaway inflation and inflation is well within control though it is at the higher corridor. They have also supported growth through easy monetary policy, transmission of credit and lower interest rates. Overall, I think RBI right now is in a pro-growth stance and they have been managing this objective quite well and they will take an appropriate action in any way, over the next four or five months bearing that spike in onion and potato price, inflation should remain within the RBI’s higher end of the comfort zone.
There is this chart which shows, these are estimates of course, of how the forecast at least of capex would be for the world at large and this is of course, universal global capex, so their estimates are, the forecasts are they will rise about 13% this year, and for 2022 the numbers haven't quite yet been baked in, but if you notice this that much unlike 2009, when there was a sharp drop post the next year which is 2010 there was hardly an uptick. This time around, could this be different, and could it help the investment cycle? Mr. Shah, you look at both global factors and local factors with aplomb. What's your sense about capex because of various shortages around the world on the supply side, and then of course, so how would India react?
Nilesh Shah: Globally, every government has to provide fiscal stimulus to cover the Covid-19 shock. The U.S. has announced a trillion-dollar infrastructure spending, and people who visit U.S., do realise that the John F Kennedy Airport is not good as good as Mumbai International Airport. So, there is a need for upgrading their infrastructure there. The same thing is happening across Europe, where they are providing fiscal stimulus by way of infrastructure spend and that is creating a new cycle of capex. If we come to India for last four or five years, private sector capex has been on the backfoot, the higher capacity utilisation was missing and hence there was limited interest in setting up investments. The load was taken by the government and now, we believe a cycle is beginning for industrials and capital expenditure, led by one government, second, by private sector investments like cement, steel, and sugar and third, by exports participation, either by a parent or by a direct supply. So, overall, I see capex cycle rising in India now supported by private investments as well and this will bode well for industrials and engineering stocks.
Mr. Shah, how does one typically play such cycles because there are idiosyncratic themes in which there are very large announcements either aided by government moves or otherwise largely by government moves—be it the Ethanol, be it the PLI schemes or otherwise. So, does one play themes which are clearly seeing a government support of some sort or the China plus one factor, or do you play the ancillaries which are supplying to all of these sectors, so to say because there the risk might be lesser of whether a sector specific theme fizzles out or no. How do you think you would see this next two, three years?
Nilesh Shah: In our opinion, you should be able to play stocks across the gamut. For example, on PLI schemes, we are seeing great opportunities in electricals, electronics, and mobile handsets. The auto auto-component policy has not been announced, but we believe as and when it is announced it will again be good for auto, auto component companies. Textile policy was announced earlier, it was not welcomed by the industry, now it has been modified and I believe finally India will get its place in the textile sectors. So, the entire PLI spectrum is available, where you can pick up the right company based on the valuation and play that investment cycle. We believe PLI cycle is a four- or five-year cycle plus, rather than short term and hence, one should invest with a medium to long term horizon. The second option is to play via industrials and engineering companies, majority of these companies over the last five years were in a very tight, cost control, as they were at volumes, utilisation was low, and they had no option but to cut cost to survive. Now they have improved their processes, cut costs and now they are fighting fit. Suddenly their order book is expanding. Their order book is expanding in the local as well as global market, their operating leverage will kick in and they will be able to generate a very decent profitability growth, way above market average. So, either you play industrials and engineering, or you play through PLI participation companies. Both have medium to longer term trends, and we think you will find many market out-performers in this spectrum.
What’s the institutional large institutional appetite Mr. Shah, or some of the smaller themes in which there have been noticeable government moves? There is, of course this much spoken about ethanol policy for a lot of people say that with the electric vehicle advent as well, who knows where that will go. So, while there was initial euphoria, a bit of doubt seeping in for certain sectors or certain quarters of the market, let me put it that way, then there is textiles, which hitherto has been sleeping but the new textile minister has been at the forefront of making changes. Those are very small sectors—drones and the whole drone policy, very small sectors. What does a large institution like you do out there, do you take some participation because you believe that these are meaningful steps or would you wait for some critical size for these companies to come up to before you take of thinking, larger or meaningful exposures there?
Nilesh Shah: In a sector like sugar, apart from size and scale governance was a big issue. There were a handful of sugar companies where you could have invested based on the governance standard and which is where you have seen institutional participation, getting restricted in the sugar sector. Now the fundamentals of business have changed. In sugar, earlier profitability would go up and down depending upon sugar prices. Higher sugar prices invariably will result into higher sugarcane production and lower sugar prices in next season. Now with ethanol coming in, there is a base profitability, and on top of sugar prices, they will create their own volatility. So, at least from an industry point of view, from a predictability point of view the sugar industry is moving from cyclical to semi-cyclical. Now we need to invest in right governance companies and your point is absolutely valid, some of these themes are very small. Within that, apart from size and scale, governance becomes a bigger issue. So, we have played some parts in textiles, sugar through our small-cap, mid- cap fund where our mandate is to invest in small and mid-cap companies but certainly when we have to invest across our portfolios, we prefer a large cap company and this is where we have chosen to invest into industrials and engineering stocks, where there is reasonably large size available.
The other question on this whole capex theme, is around the beneficiaries or potential beneficiaries or existing beneficiaries of the China plus one strategy, and you were at the forefront, talking about India being a pharmacy to the world and will the world accept that, when you look at India's role vis-à-vis China's role which has given the virus. Now my question to you is, there's a fair degree of play out that is happening into some of these themes already, but the believers believe that this is probably just the start or maybe the first leg is done and now you will actually see the companies which have moved from small to being medium sized moving from medium to large size because the world is looking eastwards and the China plus one strategy is alive and kicking out here. What are your thoughts on API's, on other backend pharma manufacturing of contract research and on speciality chemicals where I believe you’ve liked them for a while now, what is your stance now because they fall squarely into this whole capex thing because almost every company is announcing a fresh round of capex?
Nilesh Shah: For us China plus one is a great opportunity to narrow down the gap with China. In 1980, both of us are of a similar size today they are five times bigger than us. They became a manufacturer to the world and while we had our own success stories in becoming the pharmacy to the world and the back office to the world, we lost out on being a manufacturer to the world and now through PLI schemes as well as the general anti-China feelings which the world is expressing thanks to the Wuhan virus and also, other factors, we are seeing that there is a great opportunity coming for a certain sector in China plus one. Chemicals and speciality chemicals was one where just like the technology sector Y2K provided an opportunity, and that the good entrepreneurs built billion dollar companies, same way, we are seeing in chemicals. China started vacating that space because of pollution, our ability to produce niche speciality chemicals was never in doubt and slowly we became from tier two supplier to tier one supplier. We have seen multi-million-dollar contracts being awarded, we have seen a company buying more than billion dollars chemicals, obviously from different players in India. So, what happened in chemicals in the past is now likely to happen in many of the contract manufacturing segments. These companies were manufacturing on contract electrical appliances, electronics components, mobile handsets, they can become a part of the global supply chain management. In some sense, when Suzuki entered India's automobile sector in the 80s, it changed India's automobile sector forever. From being a marginal producer of automobiles, we became a large producer and exporter of automobiles. Today, automobiles contribute to 7% to 8% of India’s GDP, and more than 1/3 of India's manufacturing GDP. We believe what Suzuki did with India's automobile sector, there are many such trends happening in chemicals, probably it will happen in API, textiles, auto, auto components, electrical, electronics, and mobile handsets. They're already moving in that direction. To just give you a very small example of this China plus one, very recently, a company came out with an IPO, they are an auto component manufacturer, and they were approached by a foreign buyer from the U.S. to get bicycle components and they said but we make automobile components, and he said automobile and bicycle are the same, both help people in transporting, so can you supply to us? This kind of an inquiry earlier was very difficult to get but now people are actively seeking quality Indian suppliers and if you can capture this opportunity over the next four or five years, it can really support India in narrowing the gap with China.
Then it seems to be an opportune time to launch a multi-cap fund isn't it, Mr. Shah? I mean you get to play all of these themes large across large, mid and small, what's the rationale for that launch?
Nilesh Shah: We have been running many products in our portfolio and as size increases, you tend to become large-cap oriented. So, there was a need to launch a fund which is a one stop solution for investors. Instead of them dividing money in our emerging equity and mid-cap fund or a small-cap fund or a blue chip or a large-cap fund, they're saying that, why don't you give us a fund where you will divide in small, mid and large. So, this is a fund launched on September 8, closing on September 22. This will provide minimum 25% exposure to investors in small, mid and large at all points of time and the balance 25% will be allocated based on our proprietary model—whether large, mid or small, depending upon where the risk return opportunities are. Essentially, this is a one stop solution to customers giving exposure to stability of large-cap promises, of mid-cap growth opportunities but in small-cap.
Do you reckon that there could be a meaningful corrective move in the mid-cap and the small-cap end of the market because a lot of people talk about the froth being there and at the same time, a lot of people say that there’s such a bout of underperformance since 2018, that this is just a mean reversion of sorts? What is your thesis out here?
Nilesh Shah: In the stock market, you never say never. In January 2020, if you would have asked me, is the stock market likely to correct? My answer would have been no by March 2020, I would have fallen on my face. So, it's impossible to predict how the markets will behave but what we want to reassure investors that the longer-term growth story is still intact. Corrections are a part and parcel of any market and today, small and mid-caps have given great returns from 2020 bottom but when you look at it from 2018 top, it is still a below average return. Within small and mid-cap if you can pick up the right stocks which are showing tremendous growth opportunities because of a variety of themes like China plus one / Aatmanirbhar Bharat, home improvement, the rural sector—there are opportunities over there, where a long-term investor will still make money, but everyone has to go through the agni pariksha. By today, hand on heart if you see my SIP returns across my equity mutual funds, they are all in double digits, they are a dream come true for investors but it is available only to those investors who went through the agni pariksha in March 2020 where for three years, my SIP returns were negative. For five years many SIP returns were in bare single digits, way below bank fixed deposits. At that point of time people who didn't panic and who stayed invested, today they are enjoying double digit returns. So yes, even at today’s price, stock in small and mid-cap will deliver returns but invariably it will take an agni pariksha of you.