This week on Thank God It’s Friday, we spoke to UR Bhat, managing director of Dalton Capital Advisors on what he’s reading Indian equities, the U.S. presidential elections and the impact that it could have on markets back home, and the stocks and sectors that he favours right now.
The U.S. presidential elections will drive markets next week. What happens in case of a Hillary Clinton win? Has the market already factored this in or do we see a relief rally or do you think it may not have any significant impact?
Till about five days ago, Hilary was making it without any doubt as far as the market factoring in a potential victory is concerned. But over the last couple of days, we have seen that Trump is coming back quite strongly. That’s why there is nervousness. If Hillary were to win, the market would go back to where it was five days ago, that is slightly higher from here. Not dramatically higher from here, because it was always factored in. But if Trump were to win, there will be quite some volatility. Negative, because no one has been able to understand what he actually stands for. That is the basic problem.
If Trump does win, will you buy into that volatility or would you wait for a while before there his policies are clear?
You should really zero down on a few stocks and be ready to buy when this happens. Because basically, even though this is a bit like any other election, a candidate who is trying to make it will make wild claims, but when he or she is in power things are always the same, because if you really see, most democracies are run by bureaucracies and not really by ministers. A Trump presidency will not be dramatically different. It might change in terms of policies towards the Middle East or policies towards terrorism but as far as the economy is concerned, I do not think it will be dramatically different. The big banks will still be there and they will still do business.
Nifty May Not Go Below 8,000 Even If Trump Is Elected
But in a worst-case scenario, how much do you think can the index will fall by? 2 percent or 5 percent? What is really a good level where you see buying interest start trickling in?
Even in case of a very strong Trump victory, the market (Nifty 50) might not go much below 8,000. 8,000 has a very strong support. It is very near to the 200 day moving average and there will be a lot of buying coming is at that level. Unless there is something that simultaneously happens even in India. But with respect to the Trump presidency, for the last 5 days we have been thinking about that and probably taking calls on that and therefore a Trump presidency is not exactly unthinkable today. So people have taken positions on a potential Trump presidency and therefore will not be surprises too much. So I think 8,000 is a very good support.
IT Stocks: Slower Growth Is New Normal
We have seen substantial correction in the large cap IT stocks. How do you go about the IT sector now – are these valuations looking good to you and would you rather prefer midcaps to something like TCS?
I don’t talk about stocks but as far as the IT sector in general is concerned, it has not been a very good performer for a quite some time. In fact, the large cap ones have seen a dismal performance and have seen a huge time correction over the last several months. And that is largely because there has been a structural change in the business which the market is recognizing. It is not the same code writing anymore. So there will be probably new winners there. The old winners may not continue to be at the top of the league now. So that shake up is happening. And even the growth numbers, which were in mid-teens till recently, are now in single digits. Even NASSCOM seems to be saying that it will probably be 8-10 percent. Therefore I think we have to adjust valuations to these new paradigms. The valuations have not corrected so much, it’s the time correction that has happened. Either there will be a continued time correction or there can be a one-time correction also, when people realise that these companies are not going to grow in double digits.
The Big Pharma Market Crash
Would you stay away from pharmaceutical stocks in the face of the elections and the uncertainty over the outcome? And to add to that we had today’s crash in share prices of pharmaceutical companies on the back of a U.S. drug price collusion probe. So how bad can it get for pharmaceutical stocks and what is your take on the sector in the current scenario?
Pharmaceutical stocks have not had a very good time of late atleast. And even in the last couple of years. All of them have had FDA (Federal Drug Authority) problems in one way or the other and I think they are getting up to beating those challenges. This sort of investigation keeps on happening and one stock or the other will have some investigation going. All said and done, the U.S. healthcare system needs cheap drugs and they cannot be dependent only on the big top six companies to provide these pharmaceutical products. So it has got to be Indian companies who manufacture these, and they have already addressed that market successfully. They are having temporary problems so that is showing up in valuations. But if you are a reasonably optimistic long term investor then I think this is one sector where you should accumulate.
Could identify ‘safe sectors’ to park your money in and take shelter, in case of a Trump win? And in the event of a Hillary win, which sectors are best placed to drive the next leg of an upmove?
Export-oriented sectors are not the best placed to be in. I think you can well be neutral to underweight there. The domestic stories are the one that will continue to attract interest because investors are not coming here to play the global story, but to play the domestic story - which is more of auto, financials. Even PSU financials, at some stage I think, will become ‘buys’, probably even now because we know what the problems are. Till about 6 months ago, you could not say this. For the last 3-4 quarters PSU banks have been making heavy provisions. Now if the economy turns around, there could be quite a few companies that could start writing those provisions back. So there could be a big fillip to public sector banks going forward. Whether it is one quarter or two or three we don’t know. But if there are going to be quite some writebacks, which is a possibility because they have got non-performing assets from the steel, mining, roads, power sectors, but all these problems are being addressed. So, if these companies start production then I think there could be write-backs, because the banks have provided for between 25-40 percent of these assets. So it is worthwhile playing that. I don’t know whether you can make money in 6 months but I think you can certainly make money in the next 2 years.
If you had to choose between the beaten down PSU banks or the private banks which are trading at high valuations but have seen some earnings growth, which would you choose?
Both. I think private sector banks have shown their mettle. Probably they have not lent too much to industries. Basically they are like NBFCs. They lend to the consumer. So therefore they are doing fine and I think they continue to grow at 20 percent plus compounded annual growth rate. So I think that is something you cannot ignore. But I think these are contrarian bets, PSU banks, at this stage. But you know if 70 percent of the banking system doesn’t finance growth, there is no growth possible in this country. So therefore you have to take the bet that these people will be put back to health and they will start contributing to financing the growth of this country.
Better Regulation In Real Estate
There is some positive consensus building around realty developers. Of course there are governance issues in this sector. But what is your take on construction? You think that this is a sector that can take off?
It can. Now you have new laws that are being put in place so these companies are going to be better regulated. I am reminded of NBFCs. About 10-15 years ago they were also terribly unregulated and they used to be called great companies. But you know then lots of them fell by the side but the ones which survived were regulated almost like banks. They are doing very well now. They are giving a good fight to commercial banks. So once you start regulating a sector very well, then I think all these johnnies come lately who want to play the short term game, they will be exempt and the big ones will be there. The ones who are prepared to play by the rules, I think there will be enough opportunities for one to make money out of them.
Nearing End Of Growth Famine?
Are you really convinced that there is some recovery as far as economic growth is concerned, given the quarterly earnings we have seen so far?
If you see the first few results, probably some 400-500 companies must have produced results, I think their results have been alright. They have shown some growth. But typically you can’t extrapolate this for the next 500 or for the next 1,000 because they are the ones who probably have something to hide, so they will probably show results on the last day. So I think the public sector banks have not shown except one large private sector bank which has shown disastrous results. So I think public sector banks also might have to go the same way, the results might be quite bad. So therefore on the whole, this quarter may not be all that great. But I think we are probably coming to the end of this growth famine. And I think we start showing some sort of probably hockey stick type of growth hopefully in the next couple of years.
The Road To GST Implementation
Another area I want to talk to you about is GST. How are you reading the GST rate structure that was announced on Thursday? Do you believe that the April 1 implementation timeline is achievable?
I think the government seems to be hell bent on implementing the April 1 deadline. Probably they would do that. But I think there will be enough confusion, these are dramatic changes that will take place in the tax structure. Even otherwise tax departments are not most efficient that you can think of. So I think there will be enough problems. I think the first one or two years will be quite bad. But I think they want to achieve the target so they will probably implement from April 1. But there will be enough confusion on classification, on harmonisation and I think there will be enough litigation. So I think this too shall pass as they say, and I think by April 2018 it should be fine.
It will still take a couple of years before it starts showing up in GDP growth and inflation?
I think initially GDP might actually suffer because there will be enough litigation and misclassification. There will be some problems for probably one or two years and after that it should be fine. But even otherwise, there is hardly any country which has 5-6 slabs. The whole idea is to have one single slab. And here it is almost like the sort of taxation that we had earlier except that there will be some sort of harmonisation in terms of giving effect to the chain. But otherwise it doesn’t seem to be dramatically better than what we had initially thought.
What is the investment style that you most identify with and can you tell us about how you go about choosing your portfolio?
Well you have lots of theories about investment, about value investing, growth investing, and momentum investing. I think you should really back growth. Basically you are looking for mispriced growth. So therefore if you have a very good idea about the sector and you should always call it right when the whole crowd is calling it wrong. That is when you make money. So therefore you got to have very good insight into the sector and if you have that, and if you can meet quite lot of the big companies and try to understand the management and see who are the ones worth backing. It’s almost like PE investors who back managements. While you can have the best forecast, I think finally it is a management call. Why you are investing in a sector? Because you think that particular sector can grow and if it can grow, you should really take that call on who can capture the growth. It need not necessarily be the one who is the leader. Because if you see the indices whether it is Nifty or the BSE Sensex, the sector leadership changes over less than a decade. So therefore you should really be looking at the next sector leader, the challenger to the sector leader today. So that comes from understanding of sectors, the dynamics of the sector, understanding the management and see who are the ones who can make it happen. Because in every sector there are changes in trends and those who cap that change in trend...typically the leader thinks that he is a leader because he has done it right in the past and so he has got a god-given right to be a leader, which is not so. There is always the challenger who gets you the best returns. So therefore you should always look at the challengers who can capture leadership.
The biggest business group that has really been in news over the past one or two weeks has been the Tatas. Post the correction in their stocks is there anything that looks interesting enough now or do you think some of the stocks will remain under pressure because of obvious reasons?
I think they will be under pressure as they fight it out. I think its probably not the right time to really buy big time, but there will be a truce sometime. Either there will be a truce or the truth will come out. At that time you have to take a call. Both parties have visions probably different from each other but I think Tatas cannot be wished away easily so therefore there will certainly be very good stocks there probably after some more correction.