This is a Buyers’ Market; Best Time to Start Picking Stocks: Raamdeo Agrawal
This week on our weekly series ‘Thank God It’s Friday’, renowned investor and Joint Managing Director of Motilal Oswal Financial Services, Raamdeo Agrawal talks about where Indian equities are headed, the earnings season so far, and his investment approach.
Where do we stand today in India’s equity markets given the macroeconomic indicators and the earnings season that’s just winding down?
The market is always ready to welcome investors, and I am speaking for investors, not traders. Traders, in any case, can make money in both good and bad times. When should investors avoid the market? When it’s completely euphoric. When its so overpriced that even a shoe-boy is giving you tips, IPO markets are booming, valuations are crazy and market capitalisation to GDP is 1.5-1.8. We are not in euphoric times, markets are not depressed. Right now we are at a nice 24 degree temperature. It’s a nice shiny afternoon, you must go out shopping and build a nice portfolio. India is in a very good position. We always had to deal with high oil prices, and consequently high current account deficit. Rupee was always weak. Those problems are not there at all. The current governor has done a wonderful job. The gods have done a better job. Oil is at $40 per barrel.
Secondly, we have had ample monsoon after so many years. save for parts of Punjab, and north east, everywhere else monsoons have been robust. Even in Mumbai, we are seeing such monsoons after a very long time. This will have its own merits over the next 3-4 months. Inflation is under control. It would be desirable for it to be even lower but 6 percent is not very high.
One of the things people are missing is the global environment. we are not isolated from the global economy any more. Day after day, bond prices are going through the roof and yields are shrinking. See the FT headline. Because of bond buying, there is a global collapse in yields. Today we are almost at 7-7.1 percent, even before the (Fed) rate cut. The world is awash with liquidity. We used to curse Greenspan, Today it’s multiple times bigger than that. And India’s in a unique situation. This is one large growth economy which can attract all forms of capital. The issue is how much do we deserve to get in debt, in bonds, in equities. Equities which are good - corporations which are of a decent size, are managed well..we are blessed with lot of good corporations..and if they are reasonably priced and there is growth, there will be no dearth of buyers. You will get a crazy number of buyers for those companies. This is the time to build a portfolio of good companies. They will do well in any case. Now there’s icing on the cake, that global liquidity can push it to different levels altogether.
Not everyone is very happy with the first quarter and fourth quarter earnings. How have you read them and do you expect corporate earnings to pick up momentum going forward?
Earnings will pick up momentum. If you ask me do you know if the next quarter is going to be better than this quarter? I don’t know. That’s not the outlook.
But are you happy with this quarter?
Yes, broadly my portfolio has done well. Except for one or two disappointments, not even a disaster, everything is fine. In fact we have had more positive surprises than negatives. What has happened is that the market has become very narrow. Quality is there, companies are there, they’re stable, but companies which are very successful right now, there are only a few of them. So you have to be smart in picking those companies up. You have to actually anticipate who’ll be successful and make place for them in your portfolio. When the companies are successful and then you go buy them, it doesn’t work. You have to anticipate and then position your portfolio according to that. The QGLP format that we talk about, or the philosophy, that philosophy does exactly that. It anticipates where the ball is going to be, like a right winger who’s there hoping that when the ball will come he’ll shoot the goal.
One year forward price earnings ratio (PE) for the indices right now is around 18-19 times. Does this number matter any more right now?
See, earnings itself is depressed. How do you look at the PE multiple? When we are looking at markets, we are looking at total market capitalisation. The total market cap is Rs 110 lakh crore. The total profits of all the listed companies is over Rs 4 lakh crore. It’ll be a little higher actually because market capitalisation includes the loss making companies..all the banks are making losses but their market cap is also there. For aggregate market, it may be higher than 18 or 19 times forward PE. So, earnings are depressed. So it will exponentially increase and eventually it will peak out at, say 6 percent. In next 5-6 years, GDP will definitely double from Rs 145 lakh crore to Rs 300 lakh crore. Corporate profit to GDP, there is a co-relation. On Rs 145 lakh crore of GDP, you are making Rs 4 lakh crore profit, which is less than 3 percent. The normal levels are between 3-8 percent. So as the economy recovers, the GDP will keep growing at 10-12 percent. And corporate profits will not grow at 12 percent. Whenever it starts, it will grow at 15-20 percent or even 30 percent. If corporate profits are growing at about 6 percent, you are talking about Rs 18 lakh crore profit. So from Rs 4 lakh crore to Rs 18 lakh crore, that’s about 4-5 times growth. Keep the PE multiples same, you are talking about 4-5 times growth in the next six years.
Raamdeo’s Bull Case
That’s an extreme bull case scenario, isn’t it?
That’s because we are bulls!
You don’t think markets are over-valued right now?
Markets are not overvalued. Stocks could be, in pockets. If there is madness going on about the relative value of something..in a market of 3,000 stocks, 10-30 are going to excessively priced but not the market as a whole. At 70 percent GDP...I mean, India has traded at about 40 percent, in the absolute worst days, to 180 percent. In 2007 when we peaked out, our GDP was Rs 45 lakh crore, and market cap was Rs 73 lakh crore – 1.8 times. Today it’s just the opposite. We are at Rs 110 lakh crore market cap and Rs 145 lakh crore GDP. At 70 percent GDP, it can fall by 10 percent. I’m not saying the market can’t fall by 10-15 percent. I’ll be very surprised if in 12 months,if it’s significantly below current levels.
Hunt for Value
You have spoken extensively about value migration inprevious conversations. Where is that going to in terms of business and sectors over 5-10 years. Market dynamics are rapidly changing..which sectors could move up from current levels?
Value migration is a long story apart from a large story…. Back home, from public sector banks to private sector banks. We have only 25-30 percent banking in private sector banks and 70 percent with so called public sector banks.
‘Shift to Private Banks Playing Out’
So the large part of transition or shift has yet to be played out?
It will be other way round.. 70 percent will be private and 30 percent will be public.
The business from public sector bank to private sector bank is half played out according to you?
One third..and the best days are still ahead. Now there is a banking licence on tap and you don’t have to be a very blessed guy to get a licence. 20 licences have already been given and I don’t know how many guys will come and take it on top out of that in next 12 months or so.
Last time, out of the 10-15 licenses which were given, you have got one HDFC Bank, one Kotak Bank, IndusInd Bank, Axis Bank, ICICI Bank. These are all huge wealth creators. When HDFC Bank came, it got listed at Rs 40 bucks, 200 crore was the equity in 1996.
For Rs 800 crore you could buy the entire bank. Today the bank is worth Rs 3 lakh crore. These kind of opportunities are going to come up, and what HDFC Bank did in 20 years, these bank are going to do in 10 years.
I am concerned about where we are in the the asset cycle or bad loan cycle, because for a very long time we saw it play out in PSU banks and in the last few quarters we have seen it play out in the private sector banks as well. You have seen it with Axis Bank, you have seen it happen with ICICI Bank and word on the street is that in fact, it is going to get worse from here on for the next few quarters. Therefore how do you take stock. Are you fearful that a large part of the business these banks have been doing is fairly suspect at this point of time?
So I don’t have any view on that, you may have a better idea on that. The way we do it is that we buy the banks that don’t have troubled assets..that’s the only way to play the sector.
But how do you know that because we have discovered in the last few quarters that they were pretending that they didn’t have it..
Yes, but that’s where the investing skills come in, we have to do some homework.
Then you’re only buying HDFC Bank which doesn’t have a book on that side at all.
Yes, why do I have to have a troubled book in my book.
Okay..then we are know you are investing in HDFC...
See..the point is when you know the credit cycle is against you, you know that surprises are going to come. Even the banks don’t know how many accounts will go bad. So stay away. Somewhere there’ll be an opportunity for us to look at those banks. That’s not my style, to buy what is very cheap and that asset cycle has gone through. Fundamentally avoid these kind of situations.
So you have said two things to us so far, you’ve said that you are expecting a large part of the shift from public sector banks to private sector banks yet to play out, and on the other hand you are still telling us that many of these private sector banks might not be disclosing the real stress in their assets..stick to the safe banks..don’t buy now.
I am an investor, I have a choice, I am paying full price….I am paying price-to-book of 3 or 4. I have a choice where to invest and where not to invest..I don’t have to take responsibility of all the banks which are there. In a 17-stock or 15-stock portfolio, I need two banks and that is also not necessary. When I find an absolutely pristine bank, NBFC or housing finance company then only I will buy. It must be quality growth at reasonable price.
Even HDFC Bank currently stands under threat, because of all the technology changes we are seeing in the payments business. When do you judge, this has been a great investment but it’s time to get out.
We’re still not seeing signs of technology hurting them, technology is probably helping them. One has to remain open to the complete digital migration. Now it could be third level of value migration where from PSU banks it came to first generation private sector banks, and from first generation private sector banks the value can rapidly migrate very rapidly to second generation digital banks, but we have not yet seen signs of that yet. So when the migration happens it is a better business model. So you have to see... because it is a very large profit, in banking system you make around a lakh crore of profit.. so profit pool is very large. Private sector banks must be making approximately Rs 30-40,000 crore . Somebody has to show me that I have opened a large digital bank and it is making Rs 1000 crore of profit and it is looking to be the way to go and it is a threat to HDFC Bank.
A Small Business With 100x Return
Are you interested in..because I know sometimes you do unlisted equities….have you put money in some ‘fintech players’?
No, not fintech players but we just exited form AU Financiers, Jaipur. We bought at Rs 50-60 crore valuation, we put Rs 20 crore, which gave us 30- 35 percent. That was 6 years back. We sold it for Rs 5,000 crore..100x..that’s the power of private sector banks.
How did you find this company and how many more do you have on your list?
He walked in, he wanted to raise money and HDFC had given Rs 200 crore of credit line. That’s AU Financiers from Jaipur. You must meet Sanjay Agarwal sometime.
I have met many Sanjay Agarwals. Give us a sense of what you looked at in that company or what you saw in that company?
There was not much of a business. Of course, in financing if you underwrite very well, you do make money. The management..the person...a chartered accountant, young, passionate and with integrity.
What was he doing? A traditional lending business or online lending?
No..online lending..It was very small.. gross income of about Rs 10 crore and net profit of Rs 2 crore. We bought the whole thing in Rs 60 crore. So it is a leap of faith. We are celebrating success. We’ve had failures also. In private sector funding and banking there is a huge opportunity because this country is just exploding and the traditional banks, for whatever reason, are not able to reach out to the last mile. The branches are there but they are not going out of the branches. Even private sector banks broadly stop at branch level. All the dirty work or hard work at the client level is done by NBFCs. That’s why there is a lot of room for value creation.
Bajaj Finance: Missed Opportunity
For investors already invested in NBFCs, when do they get out? Do they get out or not? And for guys who haven’t got in and have lost out on that whole train, what do they do, ab kya kare?
Naye bande aayenge na. (New businesses will come in.) There are a lot of new ones that are coming in. I just told you about one or two. I missed Bajaj Finance. To start with Rs 30,40,50,100...I kept on being prompted by many people but I just missed it. We realised that at only Rs 2,000 per share. My other fund managers looked at it much earlier, maybe at Rs 200 or Rs 300. So as a (brokerage) house we’ve been buying. But if you ask me personally, I noticed it properly only when it went above Rs 2,500. From there it went to Rs 10,000.
There’s a saying.. ‘Don’t come in front of a speeding truck’. So if something is going at a very rapid pace...most people don’t know the power of compounding. When you grow at about, say 35 percent per annum, there are companies growing at 40 to 50 percent. Every two years it doubles. Four years it grows four times, in six years it grows eight times. Every two years they grow exponentially. So you cannot really calculate how much money they will make. So till that money-making is on at a rapid race don’t try to peg the price-to-book ratio, it doesn’t work like that. The market will respect the guys who have quality and growth. You will get to see from the quarterly results, here it is slowing down. Then you can get out, maybe at even 20 percent off the top. If you sell after it’s fallen 20 percent, you are better off than selling it at one-third the price.
Hero’s Realignment Was Expected
One of the stocks that you’ve always spoken of, when you talk about quality, is Hero, which has been in the news recently, because of yet another family reshuffle. Do you see that affecting the business?
No, I think its a brotherly thing...respected Munjal sahab is not there, so I think the family must be getting realigned to whatever they want to do. Whatever I hear, that’s how it was being run. It’s just getting formalised.
Huge Opportunites in Defence
Defence and power, what are your thoughts on these two sectors particularly?
Power is an old story. Nobody made money. So that’s settled.
Defence is a completely new game in town. This is the biggest contribution Modi government has made. That after 60 years, someone thought we must have our own defence production. It takes time. Defence is technology intensive, it’s production intensive, and precision intensive, and it has to have the safety angle. So your entire defence, all the three forces are dependent on an imported system. This (government) initiative is truly deep rooted and it’ll have a huge impact after decades, after at least 5-10 years. Nothing can be built suddenly overnight. So whatever orders we are seeing, that’ll empower companies like L&T, Bharat Forge. Actually, lot of orders haven’t gone to the private sector yet. The important thing is that this is business with the government. There are three types of businesses, B2C, B2B, B2G. B2C is the best, B2B, you have to be cautious who you’re working with. But with B2G you have to be very cautious.
Does that mean you’re an investor in defence from a 20-year point of view or a 15-year point of view or a 10-year point of view, or is it is too early to pick winners?
Too early, and we are not the venture capitalist type of guys. We’re seeing a lot of these proposals coming in, in private equity. But I have not seen anything worth investing yet. But, I think it is going to be one of the biggest opportunity and I don’t know whether it will be an investing opportunity, but it will have a huge impact on the economy.
Renewable Power: Not Worth it?
You’ve dismissed power as a potential investment opportunity given the track record of the sector and I understand that, but what about renewable sources of power, like solar, it’s the big buzz word right now.
That’s even worse I think. Because capital intensity is five times more. Say you set up a thermal power plant and you make Rs 5 crore a megawatt and actually it delivers a megawatt. With renewables, at Rs 5 crore per megawatt it delivers only 20 percent of that. So effectively if you want one megawatt power only say 12 hours a day, you still have to put up Rs 30 crore. Is this economical?
But, is it not the power source of the future?
It is the power source of future for Germany and Denmark and Norway, but not for India. We need cheap power. I think it is extremely capital intensive, though the raw material cost is zero and all the chartered accountants will make out their IRR to be 12-13 percent. If we have zero interest, of course it works. But we don’t have zero interest.
I wanted to ask if infra and utilities fall in the same bracket, because that’s another deficit that our country has right now?
We are trying to figure out the companies that make a lot of money. They make money in the day, they make money in the night, they make money in winter, they make money in summer, they make money while it is raining. We want 24x7x365 days companies. You decide which are those companies.
Smaller Portfolio, Better Portfolio?
So there goes power, there goes utilities of any kind and there goes infrastructure as well.
That’s why we only have 15-17 companies in our portfolio.
5 Steps to Smart Investing
Indian Pharma’s Global Opportunity
Your views on healthcare...now this is B2C, so this could interest you?
Healthcare is one of the most exciting sectors. It has two angles, one is domestic and the second is export oriented. So we are taking care of domestic health as well as all the global aging population, they need cheap portions of innovative medicines. So the generic versions are being supplied more and more by India. So this is going to be a bigger trend than even IT because the kind of quality India can produce, in small batches, very few other countries can do it. Even China finds it very difficult to get U.S. FDA approval for their projects. So what is happening is, it is a big mega trend, world population is aging, world is becoming more prosperous, they’re taking more medicines, and India is extremely well positioned to deliver quality medicine, in small batches, prescription driven medicines. So that’s why you see companies like Sun Pharma, which in 15-20 years is the world’s fifth or sixth largest generic company. And still, they are among the fastest growing, and I won’t be surprised if in the next 5 years they are the first or second biggest company. That’s the kind of opportunity you’re talking about.
Two questions there. One is – we have had regulatory issues and you made the point that there are many plants in China as well that have run into trouble with the U.S. FDA but we have had a spate of regulatory issues that Indian pharmaceuticals face.
Those are short-term issues. See maybe looking at the possibility and dominance of Indian companies, and the scale at which they are growing, the authorities in the U.S. must have tried to drive home the message – get your quality right. So when you scale up, you will not have issues. That is the message. That’s why you see once the companies are getting into that level, they are also getting clearances. So in the last 3-4 months you have seen major clearances.
The Cost Advantage
My second question is that we are very good at the generics game. We have not yet cracked the independent molecule game so far right? How long will this generics game serve us? The cherry on the pie is really the proprietary research, isn’t it? And we have been talking in this country for 10-15 years and nothing’s come out yet. So how do you take a view on what companies to invest in?
There are two types of innovation. One is feature innovation and second is cost innovation. So a developed country is on the features side. They have to do new things. All the new things come from the developed world. They don’t come from the emerging world. For example, everybody has a car and if the car is functioning very well, there is no defect, they want to come out with a battery car. That’s a complete disruption. Biggest value migration will happen from a combustion car to a battery car through Tesla etc. That’s one of the huge global disruptions waiting to happen. It’s just happening in front of you.
In India, we still need basic things. We cant innovate for features. Our biggest asset is that we can do everything at one-third or one-fourth cost.
But how long do you play the cost game?
It will be like IT. For the first 10 years, you play the cost game. Then they went for the scale. Now they are focusing on skill. Now there is nobody who can manage these global, complex projects. If you want 25,000 guys to implement something huge and global, it can be only Indian IT.
Heavily Invested in Pharma?
So are you still heavily invested in pharma?
Yes, we are invested. Not heavily, but what is appropriate for a company, we have invested as much.
But you have chosen to take bets across many different pharma companies that have cost to their advantage or are you sort of just narrowing your bets to one or two companies that have managed this scale game?
From the pharma sector, we have only one or two companies.
I’m sure sure you are invested in Sun. I don’t know anyone invested in pharma and not invested in Sun. So the second company is the only up for guessing right?
Sun, Lupin..there are whole lot of them. I mean it’s all disclosed portfolio.
Focus on Stocks, Not Sectors
When it comes to finding value in midcaps and smallcaps, have they all bottomed up? Or can people still invest sectorally?
It is not about sector, size etc. Ideas come in their own size and shape. You should be open to seeing any idea in any shape at any point of time or any sector. It can come from power, if there is something unique which we might have not done so far, if they come with a deep advantage, extremely well run, fully integrated, why not? We will do it. So the issue is not about sector and size. I hate this smallcap, midcap and largecap demarcation. I mean if you are buying an aviation company, it is not going to come for Rs 1,000 crore or Rs 2,000 crore. It will be Rs 10,000 or Rs 30,000 crore. So when we bought Indigo. The IPO itself is Rs 25,000-30,000 crore. What you do? Either you don’t participate, don’t look at that company, but it’s a wonderful company. So I look at the stock and whenever we find an idea, even if it is a Rs 2,000 crore idea, we will jump in. In fact yesterday I was trying for a company, which is Rs 700 crore company, with the same intensity.
If rude prices rebounded, if the Fed hikes rates and you see big disturbance in the liquidity flows, is aviation still a promising sector for you to invest in?
This doesn’t matter in aviation. I mean what matters is the competition
But 60-70 percent of the cost of aviation is crude.
But it’s all on your behalf. All cost is taken care of by companies on the customers’ behalf. The issue is, is the competition between two guys or three guys. Or there is one or two disruptive competitors? See, you sell by differentiation, or scale. If you don’t have either, you disrupt it by selling at the lowest possible price. Once you get in aviation, particularly in India, the price is extremely important.
Value in FMCG?
Within the consumer space, what interests you besides the companies you have invested in so far?
Consumption of most products in FMCG is very very low compared to world standards, even compared to developing world standards. Also, the situation is very monopolistic. If you have growth and a monopolistic situation, this is a complete open lottery to make money in, because all these companies don’t need capital. They literally work on thin capital or negative working capital whether it is Emami, Hindustan Unilever, Nestle, Britannia, Asian Paints, they hardly deploy any capital. So it’s all free cash flow. And that too growing cash flow for 10 years, 20 years, 30 years at the rate of 20 percent. The guys who are coming in with FII money are very happy. There is value in the stock. There is value in the mind of Indian consumers. For investors, it may be x, 2x, 3x depending on the source of money. So these are the kind of challenges and opportunities in the consumer space.
‘First Party Then Worry About Hangover’
I know that you are bullish on Indian markets and for all practical reasons , the last many years that we have spoken to you, you have almost always been positive about India. If the Fed were to hike the rate tomorrow or some point soon down the line, what do you make of where our markets would be?
Lets first do the party then we will care about the hangover. Markets have their own tendency of going up and down. Sometimes when the market is depressed or normal, you go and find your stocks. I don’t care much about the market. I care about the ideas that we are getting. So many wonderful companies are filing for IPOs. This time, the difference is that most of these companies are private equity funded companies. So some PE has put these companies in a nice shape before they come to the public. So you have lot of opportunities. So long as my stock is doing well, I don’t look at the 5-6 percent difference in price. I am buying the earnings power of the company. I want a reasonable price though. Say we bought Indigo at Rs 800-900. The stock price may move up or down but I am more happier to care about the quarterly results. If earnings have come as per expectations, I don’t care about the stock price. Because it will go to Rs 1,200 from Rs 200.
When I say the liquidity party ends, I am not referring to lost asset prices, I am saying today asset prices are looking good because of all this. The day theliquidity party shuts down we are going to see a naked picture of demand and that may not be a pretty picture.
This macro thing doesn’t interest me. I am simple guy with very low IQ. I want to figure out which companies make a lot of money in a given situation. Some situations will change. Sometimes Japan, U.S., Europe will fall, sometimes India as well. In the last decade, it was China. Next decade could be the story of India. So there is a good chance, 50-60 percent, that it could be a decade of India.
Only 50 and 60? Some of your competitors have called it the mother of all bull runs. The last time we spoke to Ramesh Damani he said Ab ki baar, Sensex 50,000.” He said it tongue in cheek though.
But 50 is not very far.
Since you are all all heavily invested you will only ever say are good things about the market. That’s a criticism we get from lot of investors.
I’ll make money if market goes down. If the index stays at 8,000-9,000 we can make a lot of money. You make money in two ways – one when the market itself goes up. Second when the company looks better than other companies. So the whole market might remain at Rs 100 lakh only but within that, the company can get from Rs 1,000 crore to Rs 10,000 crore. I want to make money like that.