Alpha Moguls | Investors Must Mellow Return Expectations, Says Sunil Singhania
Investors need to mellow return expectations as there are multiple reasons to be cautious after the Indian stock market's record-setting surge, according to Sunil Singhania. Better still, he advised, they should bet on long-term gains rather than trying to predict short-term trends.
“It's been a very pleasant experience for first-time investors where they only made, and have not lost money,” the founder and fund manager at Abakkus Asset Manager told BloombergQuint’s Niraj Shah on Alpha Moguls. “Therefore, the return expectations to that extent are very high.”
Singhania, however, cited multiple reasons to be circumspect. “We have already seen a huge run; we aren't as cheap as we were ever and, therefore, to that extent the return expectations from markets will have to be mellowed,” he said. “But at the same time, equity in India at least still stands out as the best asset class.”
Singhania, however, doesn't see a rise in interest rates as an immediate threat to markets. “…because of this huge liquidity and fiscal stimulus, we’ve had asset prices go up including commodities and, therefore, that led to inflation,” he said. “And when inflation goes up, the central banks obviously have to increase interest rates and suck out the liquidity; that's how the cycle moves.”
Yet, the world economies are not out of the pandemic-led issues with almost half a million cases every day, he said. No central bank or government would like to prematurely tighten so much that it hurts the recovery, he said.
And while U.S. inflation hit a 31-year high in October, Singhania said there are signs of prices stabilising or cooling.
Metal prices have softened a bit or at least they're not moving up; bulk shipping rates are down almost 30-40% as they have given up all their gains of the last quarter.
Oil prices were the predominant reason for the spike in U.S. inflation and Singhania expects these to soften since they are surging because of supply restrictions rather than demand.
These signs should allay fears of a global rise in rates, he said, adding that if at all, there may be a “little bit of a tightening”.
Singhania, however, said that it’s difficult to predict every trend and advised investors to consider long-term returns. “As your long-term outlook on normal price trends is positive, you'll have to just bear near-term ups and downs."
On New-Age Businesses
The new-age business are great but valuations are like out of the moon, he said. “We like the companies, we adore the entrepreneurs but we're staying away from investing in those really hyped companies.”
Singhania is optimistic on banks and select non-bank lenders with “great credit rating and great branding, where you and me will feel comfortable placing our deposits”.
These include so-called corporate banks as capex is coming back, and gold finance companies or lenders that have collateral.
Watch the full conversation here
Edited excerpts of the conversation
Can I start off with a couple of global questions just to understand your thinking. The basis of any alpha generation would be the kind of returns that the markets and the headline indices or the benchmark indices would make in the first place. Do you fear that after the heady run up that Indian indices have had and in fact, the word indices have had too and with the risks of if not taper tantrum, then an interest rate tantrum around the corner, would the performance of the headline indices over the next 12 months be materially different from what has been in the past 12 to 24?
SUNIL SINGHANIA: So I think, all the reasons you mentioned definitely exists. So, whether it's inflation fear, whether it is the fear of tapering, whether it's the fear of interest rates increase, they're all there. The only good thing is that in some measure, the market is already expecting that and our experience is very clear things which we already expect when they happen, the impact is not that great so to that extent, we are not unduly worried about those fears. But you rightly said that the worry is more about the return expectations and we are in a scenario where we are coming out of 18 months of superlative returns and in an environment where we had all given up hope of not even knowing whether we will be alive or not and then to come out of it richer than ever, obviously the return expectations had gone up. There are a lot of investors I would say more than 50-60% of the investors who have had first romance with the markets and it's been a very pleasant experience to these first time investors where they only made money and they have not lost money. Therefore I think the return expectations to that extent are very high. There is absolutely no doubt in our mind, and I will say that in the minds of most experienced investors that return expectations have to be much more mellowed as we move forward for a multiple of reasons. We have already seen a huge run second is we are not as cheap as we were ever and therefore to that extent the return expectations from markets will have to be mellowed but at the same time our view is that equity in India at least still stands out and is coming out as the best asset class.
There is a lot of argument and I don't know how much weightage you give to this but there is a lot of argument around whether central bankers around the world move ahead in the path of financial repression or do they lean on higher interest rates because they don't want inflation to go out of control? Any thoughts that you give or any credence that you give to this and why would be the case and what could the impact of that be on equities at large?
SUNIL SINGHANIA: One is, it is an obvious thought that because of this huge liquidity and fiscal stimulus we’ve had asset prices go up including commodities and therefore that's led to inflation and when inflation goes up, the central banks obviously have to increase interest rates and suck out the liquidity and that's how the cycle moves. The only thing is that we are not yet in a situation where economies around the world are out of the pandemic-led issues. We still have the number of cases, almost half a million every day, all over the world. We have had cases increase in countries like say Germany, in U.S. they continue to be more than 50,000 a day and to that extent no central bank or no government would like to tighten so much that this economic recovery becomes a big issue.
The second thing is yes, inflation has come out. In fact, in the U.S. it has come out at a 31-year high in October. Actually, if you see now, metal prices have softened a bit or at least they're not moving up. Oil prices our view is that they have been at $80 plus largely because of supply side restrictions rather than demand side growth going up and fundamentally we are of the opinion that oil should not be more than $60-$65 and with both China and U.S. now looking at inflation very seriously, at least our view is that you might see a little bit of softening as far as oil prices are concerned and oil prices have been the pre-dominant reason why inflation has over 6% in October in the U.S. So a mix of maybe a little bit of a tightening but as we move forward inflation coming off should allay the fears of very aggressive interest rate hikes or tightening by central banks all over the world.
Just one quick follow up with the India context as well, all the companies almost without exception, that I have interviewed in the quarter two conversations seem to be talking towards price hikes being the only way to combat the immediate threat of rising raw material prices/supply chain issues or raw material availability issues. Could that bring a little bit of a surprise to India because hitherto our central bank has been on the forefront in saying, don’t worry it is transient and we are here. Would there be a surprise in India or you don't think so?
SUNIL SINGHANIA: All the companies that we have interviewed in the last 10-15 days are talking based on what has happened over the last three to six months. Again, just move ahead a little bit. One is shipping costs have significantly come off from their highs. In fact, bulk rates on the shipping side are down almost 30-40% as they have given up all their gains of the last quarter. Hopefully the container situation will also improve and shipping costs will come off quite significantly. More than the cost or the logistics issue of containers not being available is also easing out a bit and I think to that extent raw material prices should ease off. We are already seeing in a lot of chemicals for example, prices soften a little bit.
Metals as I mentioned they’ve have stopped rising. Obviously, the demand is still high and they are not falling. So our view is that incremental probability of a major increase in input costs should start coming down quite a lot. As far as price rise concerns go, it is obvious even looking at the results of September quarter that gross margins for a lot of companies have been hit because of input costs and to some extent, they will have to increase the prices and I think that is a very logical step which most companies would take. So, we have to be prepared for some price rises. The only good thing is that we are in a very strong demand scenario as far as the festive season is concerned in India as well as overseas and a moderate price increase would be more than absorbed, I would say by the consumers. At this point of time, it's not as worrying but as you said earlier if these price rises but not controlled then obviously the central banks at some point of time will have to act.
How have you navigated through, observed or acted upon all of these supply chain issues that might be impacting companies both on the positive and the negative side because it becomes difficult at times for mere mortals to not look at those profit numbers that went up for say, some chemical companies and think that oh, did I get left behind? How did you navigate through this whole thing in the last six months?
SUNIL SINGHANIA: I think it's very difficult to catch each and every trend and it is very difficult to keep on getting in and getting out of companies based on near term profits which might be great or not so great. So, we have had companies which have benefited a lot because of this and then we also have had companies which have faced the barrage of input costs increases. So, at the portfolio level, I think they match each other as long as your long-term outlook on normal price trends is positive, I think these near term ups and downs—you'll have to just bear them as investors. No company can make disproportionate profits forever and no company will survive if they don't have reasonable profits forever. I think that is a thing what we have to look at.
It is a good thing that we’ve burned our fingers many times in the past because of these 25 years of being an investor and therefore you know when you have to become greedy and when you have to be a little bit careful. So, whenever the return on equity becomes 100% for every incremental capex, I think we become a very cautious and that was happening in almost all speciality chemical companies, companies were trading at 80-90 P/E multiple. They were trading at like 10 times or 12 times and even now, there are a lot of companies which are trading and these are chemical companies. These are not the very high end consumption companies which can trade at multiple of sales. At some point of time, you have to say let others make money, we are better off not making this kind of money. From our perspective, what we have told our investors is that last year we were in the powerplay, we were there to hit fours and sixes but we are now in the middle overs. We want to ensure that we keep on taking the ones and twos but we don't lose a wicket. So, we are okay, if we at 1 or 2% lower than the peer group at this point of time, but more in the fundamental focus, we are fine.
Would you say that this year, you are actually focusing more on trying to ensure steadiness in the portfolio as opposed to trying to really hit the big sixes?
SUNIL SINGHANIA: Steadiness in the portfolio is always an attempt. You don't want the portfolio to be very volatile and that is the advantage of having a diversified portfolio but basically we are saying is that investors have made great returns. There is always this layer of chasing momentum and when you start chasing momentum fundamentals go for a toss. So, the logic of buying a stock then does not become fundamental. The logic of buying a stock then becomes that someone else will come in buy it higher from you or the fear of missing out or some company coming in some index and therefore, the price moves up and so and so forth. We are displaying those things we are focusing on fundamentals. As I said it is possible that fundamentals, in the near term might obviously have their own chart but ultimately, as long as we're able to generate this mid-teen kind of returns we are more than happy. We are in a scenario where you where your fixed income returns are going to be net of tax three, three and a half percent. Therefore, our view is that even if you're able to generate anywhere between 13-14% to 17-18%, return sustainably, the investors would be more than happy and that mid-teen kind of returns would come not from the re-rating, our view is that we have to have a portfolio where the investing companies have profit growth of 14-15% year after year.
I'm just wondering if it's becoming a bit difficult to predict that earnings growth in a scenario which is so challenged and more so not just here on the next 12 months, but also the last six to nine months wherein we’ve had constant lockdown threats, the supply chain issues which have come to the fore, now?
SUNIL SINGHANIA: Earnings projections are always difficult as investors are very demanding and if the company does not do well on a quarterly basis, we go and get into a call and we are very agitated and we ask difficult questions. But at the back of the mind, you really pity as well as envy the entrepreneurs, they are doing such great jobs. They are facing headwinds in energy costs, in logistics and input costs, constant changes and regulations, supply chain issues and still, we expect them to perform quarter after quarter. But notwithstanding that, I think at some point of time we have to be very clear that every quarter every company will not perform as per what you want them to. There are always going to be some challenges which might come and a there are a lot of cases where there will also be situations where they will do much well than what you had anticipated. So even if you see September quarter there have been so many companies which have done significantly better than what anyone expected like building material companies, I saw some, garment companies and innerwear companies which have done phenomenally well. At the same time, there have been companies where expectations were very high like chemical companies where margins have just gone for a toss. Ultimately, as I said you have to see what a long-term sustainable margin trajectory for a sector is. A company might do slightly better than the long-term trajectory, but significantly better margins don't last.
Was this whole realisation about entrepreneurial stuff being such an important thing a factor of your own entrepreneurial journey?
SUNIL SINGHANIA: Even when I was in Reliance Mutual Fund, the preeminent thought process in investing in equity, and selecting companies was the underlying belief that India grows because of entrepreneurship and despite the government. So, the entrepreneur-backed companies are the ones which have grown faster and they can be even professional companies. Even in banks, for example, they are not owned by anyone, but the CEOs have been like entrepreneurs and those are the companies which have done very well. Therefore, at some point of time, I thought on my left were all backed entrepreneurs and here I was chickening out becoming an entrepreneur and that was the thought process of turning into an entrepreneur and I think that thought continues. India, to some extent is like the U.S., we have 1000s and lakhs of entrepreneurs who are working hard despite all the headwinds which keep on coming, being a rapidly growing and an intensive democracy. Entrepreneurs are finding ways of growing and I think those are the companies which you have to really admire.
Where is it that you found off-late, this confluence of great entrepreneurship, as well as, how do I say, performance and external support all of them coming together because I think in a manner of speaking a lot of your peer set is telling me that this is one of the rare times when they are seeing tremendous will have the part of the powers to be of the government to support entrepreneurship. Maybe it started with the corporate tax cut, but since then, it's been a one way right so to say?
SUNIL SINGHANIA: If you go back in India's history, when we got independence, obviously the basic aim of our fathers and forefathers was roti, kapda and makan. They wanted to ensure good food, good clothes and a house for their family. As we move towards the 70s-80s that is the first time when Indian entrepreneurs came into being but still it was license raj, it was not all that great. All the Indians who were studying ended well when they migrated overseas to find better opportunities because obviously, coming from middle class, making slightly more was more important than staying in the country but as we have progressed now, people have got richer and wealthier. Their kids are going abroad, but they want to come back and do something in India and I think that is what is going to change the growth story of India going forward dramatically.
Even now when we see entrepreneurship in India it is like never before and we can question the valuations at which some of these companies are trading and getting listed but hats off to all those entrepreneurs for creating enterprises out of nowhere. They have got so much, FDI for India and they have brought India into the mainstream as far as investors are concerned and they have created so many jobs for India and I think that is what is going to drive the next I would say wave of superlative growth for India. So, this 7-8% growth which was on and off coming and going I think that can be sustainably achievable in India and a large part of it will be because of these entrepreneurs and I will say the government of India has also realised that for a large democracy like India to grow, we have to create jobs. Jobs cannot be created just by the old traditional sectors. You need manufacturing in India, which is where the PLI scheme and all is helping and you also need to encourage entrepreneurship which is all these start-ups and the support to the start-ups is helping. One good thing is that capital is available in plenty. An entrepreneurship needs capital, gone are the days where to set up a business you need Rs 500,000 crore now if you a good idea, you have passion, you have the capability, there are more than enough people waiting in the queue to invest and I think that is interesting and that would make all our future professional lives all the more enriching as well as interesting.
Let me try and meet some classifications manufacturing versus services. Where is the hand tilting towards? Let's say five years out not just the next 12 months?
SUNIL SINGHANIA: It is very easy to sit in a small room like what I'm sitting in and make a presentation which is very glossy, have credentials of experience, having studied in IIT or raise money and do some services. But at some point of time, the economy needs everything. Only having apps is not going to drive the economy, only setting up gaming companies is not going to drive the economy. At some point of time, you will need to have someone make steel and aluminium and paper and cement and so on and so forth. So, I think we need a mix of both. The good thing is even in manufacturing, it's now becoming much more cleaner, interest rates are quite competitive. One thing which India always lagged behind is high interest rates and specifically for capital intensive industries—very high interest rates is never an incentive to set up capacity.
So hopefully, that is also in favour. So, I think both will go hand in hand. For an economy to grow, you need manufacturing, you need services and you also need technology. Unfortunately, in India, the IT services companies are huge, but we don't have an innovative technology company as of yet but the start-ups are actually doing what a lot of our IT services companies should have been doing. They are sitting on like billions and billions of dollars of cash but all the innovation is coming from all the start-ups. So, I would say that for a holistic growth of the economy, all these segments have to fire together.
Let's assume some of them fire together, you would still choose the best amongst them equals? Which pockets within manufacturing, let's start with that?
SUNIL SINGHANIA: It's actually very difficult but we are a little bit to some extent conservative and old school investors and we look at underlying profit. We're not averse to growth, but the price paid should be justified by the growth rates. So, we are okay to invest in a 30% growing company at 40-50 P/E. We are not okay with investing in a 10% growing company at 80 P/E. At the same time in manufacturing, on and off you tend to write off a lot of these industries that these are cyclical industries and so on and so forth but our view is that every sector has an opportunity at a price. We have seen how metals have done and how some of the other companies have done but having learned lessons the hard way over the last 25 years, one has to be very clear about how you take risk in a portfolio and therefore deep cyclicals is something where we don't invest more than 5-8% of the portfolio. I would still believe that on the services side, on the pharma side, even on the chemical side, India is globally there and therefore these sectors will keep on presenting opportunities time and again. If you remember seven-eight years back an IT services company was written off that so much automation is happening we might not need people only but at this point of time, not only have these companies grown consistently above 15% but we are now having a shortage of people which are needed for these IT services companies. So, when you have global competence you can't write it off. Again, the new age business are great, I love the digital space. I think there's so much more to do for a country like India in the digital space but valuations are like out of the moon. Therefore, we like the companies, we adore the entrepreneurs but we are staying away from investing in those really hyped companies.
So, you said at the start that you are not the hope trade investors I think a lot of people are betting on the new age tech companies comparing them to what an Amazon was in 2003-2004. You think you would want to wait for the proof of the pudding before you think of or even if you buy it expensive, maybe?
SUNIL SINGHANIA: I'm very sure that a few of them would turn out to be what Amazon turned out to be but that would be a small percentage of it. It's not that every company is going to become an Amazon. It's not happened in the U.S., how can it happen in India? So, in the digital world, the winner takes all. When you have Amazon then you have nothing. One thing that is something which we have to accept and realise and that is where we don't want to play the hope trade. As I said we are very open. We love the digital space and wherever we get an opportunity, we have been very aggressive investors. In fact, some of our winners in the portfolio have been new-age companies on the digital side and on the tech side. So, while being conservative investors wherever we have got an opportunity—just like I said, in the powerplay you don't have to hit all the balls for sixes but if you get a loose ball, don't spare it. That is what the attempt is.
You mentioned deep cyclicals even though some of them may look attractive, you're not sizing up the portfolio too much is that therefore to assume that in commodity companies metals, maybe cement thrown in there, you may like them, but you're not oversizing your positions there?
SUNIL SINGHANIA: In commodities you have the domestic commodities like cement which are more stable I would say in terms of pricing. Then you have global commodities like metals and steel, where the pricing depends on what is happening in the global and we don't compare India cement prices with XYZ country cement prices but on metals you have to compare because they are easily transportable, you can import export, so on and so forth. China being 50% of almost all commodities production and consumption a lot depends on what China does and we all know how erratic China is and they can do whatever they want. Therefore, even though the balance sheets have been repaired significantly and the stocks have become very fundamentally strong in the near term, there is always a risk of metal prices globally going up and down not purely based on fundamentals but what China wants to do. Therefore, as a risk measurement tool, we size our portfolio accordingly.
So not sizing it up too much, keeping it to a particular level?
SUNIL SINGHANIA: As I said, I have learned the hard way, the biggest lesson is when you pay fees to learn it and which is by having some rough investment issues in your past history.
BFSI has been intriguing and I'll split it into two lending and non-lending. I first want to speak about the lenders wherein there is to my mind at least a kind of newness to that when other premium NBFCs price to perfection and then there's a belief of a tech layer added on it on the large banks there is a bit of a change in the leadership so to say, at least in the minds of a lot of sell side brokers and even in the terms of the way the market is rewarded and there's a bunch of these mid-size lenders as well as PSU lenders coming to the fore finally, if you will. How are you approaching this? Do you like lending BFSI and why or why not and then within that, how are you approaching it?
SUNIL SINGHANIA: I think we are incrementally quite optimistic on the lending. I would say banks as well as select NBFCs but you have to remember one thing that the raw material for lending companies is cheaper deposits, therefore restrict to banks and NBFCs which have great credit rating and great branding, where you and I’ll feel comfortable placing our deposits. So that is one thing. Second is, it is very easy to compartmentalise a lot of lending institutions. So, this is a retail bank so they should get four times book. This is not a retail bank, this would get a one-time book but when you see the composition between the so-called largest retail sector bank and the largest corporate bank you find that the corporate bank had more retail than the retail-retail bank and it's been clearly demonstrated in the dispersion as far as returns are concerned. It is the same case with a lot of others and even in NBFCs just because you make a presentation and say that now you're a digital lending institution, you start to get a abnormal P/E multiples, I think we are focusing a lot on news flows. An auto-parts company comes and says we have developed an electric vehicle part, the valuations will go up significantly. Now, an EV as well as a normal two-wheeler will have 80-90% parts which are common. The only thing is, instead of an engine you will have a battery. Otherwise the mirrors and everything will be common so the same part can go into it. So, I think at this point of time, news flow is also driving the mindset of investors. The third thing is comfort because you have had a good experience in the past you believe that, that experience is going to continue. Therefore, you have this dispersion as far as preferences is concerned in terms of your investment decision. I think we are quite optimistic on a few so-called corporate banks. Our view is that as we move forward, the corporate capex is also coming back. The advanced growth rate will increase, old legacy of NPAs and all are behind us and there is a huge I would say traction in terms of reported PAT which we're already seeing. NBFCs we are sticking to the names where as I said, the brand is good, the valuations are in our favour and the loans are against collateral. So, in a Gold finance company or lenders which have collateral rather than just personal loans or no collateral—I think we prefer the collateralised lenders.
Just a quick word on the non-lending side as well because I presume you are and I heard you somewhere else and you said that you like that. But that's a very chalk and cheese kind of a thing wherein, for example, unless I'm wrong, insurance to the minds of many is priced to near perfection and then there are a bunch of others as well. How do you again navigate through this?
SUNIL SINGHANIA: The advantage of non-funded NBFCs is that they don't need constant infusion of capital. For fund-based lenders, you need constant infusion of capital and in case of non-lenders, you don't need capital particularly now that almost all the sub segments are generating profit—whether it is life insurance companies, non-life insurance companies, broking companies, asset management companies and so on and so forth. The other thing is we are already seeing this huge move towards financialisation of savings in India. Number of investors are shooting up, the realisation of having an insurance both on the health side as well as the life insurance only when accentuated by what happened during the Covid time. Therefore, I think with such a large country and with entry barriers due to regulations as well as on the network side, our view is that these can be great compounders and therefore across whether they are brokers or exchanges or wealth managers or even insurance companies, our view is quite positive overall. Now within that obviously from an investor's perspective, the investor will have to take a call of which is expensive and which is not expensive and what they like and what they don't like but we like the overall space.
Last couple of questions, one is on the old economy if you will, and you already mentioned capex, so that is fine, but besides that also, we’ve seen for example, a burst interest for power, we’ve seen a burst of interest for PSUs which have a dominant position which were hitherto always thought that, no we don’t want to invest in a PSU. What's your sense out here? I'm sure your bottoms up but still can I just kind of broadly bucket it as PSUs?
SUNIL SINGHANIA: The core sectors whether it is power, steel, metals, cement and a lot of others, ultimately their demand keeps on rising in an emerging economy. So, far luckily for them, there is nothing which has disrupted them. So, if you need steel, you need steel, you don’t have something on the computer to replace it. If you need power you need and in fact, the demand for power will only go up as we use technology more and at some point of time because of the last five, seven years, these sectors were not doing well, there were no new investments which came in. Suddenly the demand kept on going up the supply was not there and now we are in a situation where there is a risk of shortage which we saw in power for example. Again, to some extent, there is a little bit of hype also in some companies because of this huge move towards renewables. We are in the midst of COP26 where all the leaders are talking about decarbonisation and net zero and so on and so forth. I think it's become a mainstream topic but at some point of time, these companies will keep on giving you decent returns.
The other thing I asked you was about this old economy returning, the PSUs and the monopolies?
SUNIL SINGHANIA: With the PSUs, we follow a framework which we call the MEETS framework, where M is management in the PSU side that M used to be always a negative because one, there is frequent change of leadership in the PSUs, second is whether we like it or not, there is some intervention of the government. It's reducing quite significantly but it is still there. Third, there is no focus on return on equity. They will invest because there is a directive to invest maybe and therefore these companies despite low P/E but justifiably low P/E because the allocation of fresh capital was always a question mark. The good thing is that that's changing, at least on the talks. So, when the secretaries of various departments come in, when the divestment secretary comes on media and talks, they are talking as if they are private sector guys. There is a lot of move towards professionalising them, listing a lot of them is also helping and because the minority investors are also becoming more proactive and questioning them, there is also a pressure and then even the media keeps on questioning them. So, there is a good move towards a change. At the same time, one has to realise that a lot of these companies and the PSUs are predominantly in a few sectors. So, you have metals and mining, you have power and ancillary sectors, you have banks and funding institutions and you have defence sectors, these companies are predominantly present and quite a few of them are still dependent on government businesses, and therefore, there is always going to be some choppiness in there. While they are great from a valuation perspective, we would be very selective from a very long-term perspective.