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Fear Psychosis Is Providing Opportunities To Investors, Says Madhusudan Kela

MK Ventures’ Madhu Kela explains the factors investors must examine while looking out for “mispriced opportunities”.

A trader reacts as he looks at financial data on computer screens on the trading floor. Photographer: Luke MacGregor/Bloomberg
A trader reacts as he looks at financial data on computer screens on the trading floor. Photographer: Luke MacGregor/Bloomberg

There is a fear psychosis in the markets and that’s providing opportunities to investors, according to veteran stock picker and fund manager Madhusudan Kela.

The market value of companies can erode substantially by something as simple as a WhatsApp forward containing rumours, said Kela, who founded investment firm MK Ventures after leaving Reliance Group. “In the past, corrections were moderate and up to 30-40 percent; corrections these days can easily be 80-90 percent and swift.”

Investors should examine certain factors while looking out for “mis-priced opportunities”, Kela said. Stocks of companies that have declined but have a new management may be a good idea, he said, adding the new promoters would have done their homework before investing. Kela cited the example of Reliance Nippon Asset Management Ltd. (where he was chief investment officer until late-2010), whose market value rose after Japan’s Nippon Life took control of the Anil Ambani group company.

Kela’s enthusiasm also stems from the government’s reforms over the past few years—such as goods and service tax and the recent cuts in corporate taxes. The government, he said, is listening to the markets and is approaching issues methodically. He also expects large-scale divestments of state-run enterprises this year, which will have many takers.

A recovery in mid-sized companies can happen only if mutual fund rules—including those for investing via thresholds—are reviewed, he said. That would boost investor appetite for such firms, he said.

Watch | Madhusudan Kela on what investors must examine while looking out for “mis-priced opportunities”

Here are the edited excerpts from the interview...

You were missing from the media for a while now and you’ve been sitting and watching, what have you picked up from the pulse of the market?

I think if you look at the whole structure of the market that has happened specifically in the last two years, there were people who were leveraged, there were leveraged promoters, leveraged companies or whenever there was some doubt in corporate governance. Essentially, a combination of these three. If you look at the earlier days, we used to lose 10-40 percent. These days, if you are in the wrong stock or in the wrong company, you lose 80 percent, 90 percent or even 95 percent. It just collapses.

You have to understand that if you are a promoter, even if you are a credible guy and if you have some shares, there is no refinancing that is available. The NBFCs do not have money, they don’t want to lend against shares. Banks have become tighter. So, if a company had Rs 5,000-crore market cap, for whatever reason, the promoter had borrowed Rs 250 crore, that Rs 250 crore sustaining on a Rs 5,000-crore market cap also becomes difficult. I have seen companies just collapse. Let me tell you with my experience of 30 years, all of them were not frauds of cheats.

Even if you have to fall back on re-financing your loan or restructuring your debt, everyone is just hands off.

You can still do something if its company’s debt. Banks are obliged but that also is moving very slow. But personal debt of any nature— you are doomed.

Do you feel that there is much more gloom about the situation than it actually is, according to you?

Let me say, the situation has been bad. There’s absolutely no doubt about it. Where we are coming from where there are so many established companies, groups years for which they’ve around, they have also fallen apart. So, they’re obviously very scared and the extrapolation is happening. I have seen a XYZ fall and even ABC can fall. Now, there is no chance of ABC falling eminently but they are so scared because of what they have seen in the last two years. Obviously, in terms of scare, there is a lot more scare in the market than the actual near-term reality is.

I don’t know such enormous volumes are happening, a lot of my friends tell me that these are all computer generated and these are AI generated but you see so many crores of shares getting traded and you know, these days it is very fashionable and you just see anything that comes around on WhatsApp and I am no one to comment whether it is intentionally done or whether there is a cartel behind it, I don’t know any of this and it impacts the stock immediately. We are living in the digital world and everyone wants to act at the same time- whether it is buying or selling. So, I feel there is a lot of fear psychosis which is there in the markets today.

Just see anything that comes around on WhatsApp and I am no one to comment whether it is intentionally done or whether there is a cartel behind it, I don’t know any of this and it impacts the stock immediately. We are living in the digital world and everyone wants to act at the same time—whether it is buying or selling. So, I feel there is a lot of fear psychosis which is there in the markets today.

I was having a conversation with Guy Spier earlier on and he said, “Fear is a friend”; When the rest of the markets are hands off, that’s the time that you step in and that’s the time that youcan genuinely find those value buys. Is that something that you feel too?

That is possibly why I am here. I agree that this time around, markets are giving you that opportunity. Let’s say, if there were a hundred people who were serving a business, obviously 50 of my language have gone into a coma or into the ICU. Hence, the balance 50 are actually serving the opportunity.

The competition has gotten reduced which is why you’re seeing such a polarised nature of the market which is the case everywhere. You can see that in pharma companies, you can see that in FMCG companies, you can see that in NBFCs, you can see that in banks. There are 40 banks listed but only 5 are doing well. That is because of all the deposits and all the borrowing. They are in a seller’s market.

If you can say, I can lend you Rs 5,000 crore and that is the only guy who can lend, I can demand 25-50 basis points more cost. So that is why you are seeing this polarisation in the market.

However, I broadly categorise this into three parts; one, this ‘holier than thou’ companies which is anything where I am ready to pay any amount. The other spectrum is, untouchable where the people have gone into absolute distress and a very unorganised balance sheet and have a very severe level of problems.

Then, there are these mid companies where there is a perception which we are talking about, the reality is not as bad as it is looking like. So that’s where the real opportunity value is. A lot of these companies will emerge from these perception gaps which is what we have seen in the past and some of them will change hands. So, let me give you an example, for instance let’s say so many companies which change hands where the management has changed, and you see that the kind of value creation which is happening. So, I personally feel that over the few years, a lot of companies will change hands and we will see a different level of value creation.

Just for instance, Blackstone bought Essel Propack and the management control to change hands. Now if BlackStone has bought a company with management control, they have assumingly done all the homework. What I am trying to say is that, there are a lot of similar examples. See what has happened to the Reliance Nippon Asset Management market cap. I’ve been a proud employee of RNAM and the company was fantastically run. But just the management changed at what the market wanted and see what happened.

That probably changes the perception of risk?

Yes, that is the point. In reality, there were no problems in the way it was run and before. We have all grown in that company, so we are a part of it. So, perception wise, we believed that there is a problem.

So, let’s talk about the positives. What’s the silver lining according to you?

The silver linings are many; the behaviour is going through unprecedented changes which is creating opportunity. Second, the government is hearing and they are being proactive, and I think they are methodically approaching issues. So, if you see what happened to the corporate taxation, in a country like India when you put up a new manufacturing unit, you can get 17 tax compared to 35 percent one year back. I think it’s a huge cut, and it is not for one year, it is perpetual.

We are now seeing that the GST impact will come, the positive GST impact has started to be felt into the market, there are so many GST rates that have got rationalised. So, across the board , government is listening. One of my biggest conviction is that, you will see large scale divestment from the government. If you do anything, the government will require money and what was happening over the last ten years— I think it was generally a bad way of investing that you invested 30 percent of SAIL by doing ETFs- which is basically beating the valuation in price yourself. You are a big seller in the market, right? I think the mood is changing like what we heard for BPCL that the privatisation will happen.

Now India is a unique case in which the balance sheet is still very strong and the problem is in P&L which is your regular account. The moment when you are willing to open the purse on the balance sheet side, I think the government can realise that, even Rs 2-3 lakh every year for the two years by starting to do strategic disinvestment is possible. These are strong companies and you’ll have buyers for this company locally as well as globally. I am very sure that you’ll have buyers for this companies.

The moment when you are willing to open the purse on the balance sheet side, I think the government can realise that, even Rs 2-3 lakh every year for the two years by starting to do strategic disinvestment is possible.

Do you think that the disruption where all of these steps that the government has taken in the past is a foundation to a much stronger growth?

Eventually, yes.

How long, then?

That is very difficult to pinpoint. In the short-term, let’s say you want to become healthy, so to become healthy, you have to work hard, its not hunky dory. So, there is a system which is going on for 50-60 years, there is a fundamental change that is getting done in the system. So, there is a side effect of that, and we have to all bear the pain.

Now, you can think that it will be back to normal within 12 months or 6 months but wherever they go, I think there will be a very strong and healthy India which will be ready for people who are committed, honest and people who are willing to work hard, I think there will be lots and lots of opportunities.

Specifically, if you see the problem is, I call it the old economic stock market side. In the start-up world, there is like a Diwali going on since the last so many years and so many unicorns coming up and so much wealth is getting created. So, wealth I think is getting much more distributed than what it had been in the past 50-60 years. That looks like the design of the government.

if you see the problem is, I call it the old economic stock market side. In the start-up world, there is like a Diwali going on since the last so many years and so many unicorns coming up and so much wealth is getting created. So, wealth I think is getting much more distributed than what it had been in the past 50-60 years.
Madhusudan Kela, Founder, MK Ventures

So what is keeping FIIs out?  While the first backseat that they took it was when the surcharge was announced but one cannot pull that back. The government has opened the FDI and sectors.

There is a combination of things. One, you haven’t had your earnings growth from the corporate sector for the last five to six years. So, that is one clear thing. Second, there were developed markets that were doing so well. So, the U.S. markets were delivering and there were so many good companies so people were buying that and why would take a risk on the emerging markets and on the top of that, as you rightly said, we were getting the rumours. Somebody sitting in America hears all of these rumours so therefore, they are scared and there’s a combination of factors which are generic to the emerging market.

I don’t think the FIIs was a case that they didn’t want to invest specifically in India but we were part of the global basket. So, there were a couple of reasons specific to India. We have seen some changes in the past 5 to 7 days—at least those flows are coming back.

I was sitting and analysing your portfolio and you were trying to take riskier bets. But obviously, from a business standpoint with the tax cuts being announced, is that the environment can start taking a little bit of risk to accelerate growth? But from a stock market standpoint, when does that risk appetite truly come back?

There are a few points here. One, I don’t think you need to be extraordinarily adventurous to make money in the markets today. Because in the mid bracket, there are so many good companies which are available; which are small-mid cap and even some large cap companies are available at reasonable valuation. Because of the perception issue, for example, look at State Bank of India. If there was a perception issue, then how can State Bank trade at 0.6-0.7 times of book value? Given whatever is happening, the perception is there are too many write-offs which are there in the pipeline but a lot of write-offs and a lot more is there. What can you do to that? So, I’m just saying that is one issue which is there, and you don’t need to take any extraordinary risk or be any extra brave to find good returns in the market. So, that’s the point number one.

Point number two is that, when you identify a company, because of the regulation change that has happened; which came from the regulator that mutual funds can fundamentally invest this much percentage you can invest in a small cap, mid cap and large cap companies. That bifurcation has happened so, so many of the small and mid-cap companies which are below 7-8 thousand below market cap is completely being left out from the investing universe. This is a very important point, the market itself has gotten beaten down and whatever market which was there for these companies has also been taken away. I am sure in an amount of time; they will review the list itself on the fundamentals because the market as a whole has collapsed. The Rs 8,000-crore was a static number, so a lot of good companies are left out.

It is the more popular stocks that come into the eye of the retail participant as well?

The retail participant has anyway got smashed because of what I explained to you. We were looking at the top 1,000 companies; there are 50 percent of those companies which have lost about 50 percent of the market cap. Like, 550 companies have lost around 50 percent of the market cap. There is obviously retail ownership in these companies was very high and the retail public will only come when there is a confidence that earnings will look better, there will be some level of buoyancy that would be felt in the market.

Now, the retail public anyway is coming through mutual funds. People are investing regularly in those mutual funds and in turn, those mutual funds are not investing in those companies. So, that is the gap now.

Around 550 companies (of top 1,000 companies we were looking at) have lost around 50 percent of the market cap. There is obviously retail ownership in these companies was very high and the retail public will only come when there is a confidence that earnings will look better.

Do you feel that from a retail investor standpoint, the portfolio which is for example divided between large caps and mid-caps by the pure function of the fact that these large caps have overshot the midcaps and the midcaps have underperformed. The inherent weightage of those large caps has gone away. But they are still ready to buy more large caps and take risk on that.

See, I have run money for such a long period of time and now, this is a hiding time. Whatever works, is what a fund manager would like to do. You don’t want to be adventurous and people who want to be adventurous in the last two years, have burned their fingers badly and plus, all large companies have benefitted disproportionately because of the tax cut rate. So, if they were available at let’s say, a 10 P/E multiple, because of the tax cut itself, suddenly, the P/E multiple has fallen by 20 percent. So, to that extent, it has given you that much more headroom. Even if you were at the same valuation, the stock price justification of more than 25 percent than what it was before the tax cut is justifiable.

In light of that, you are saying its still okay to bet?

It is okay because these are companies which are actually delivering returns, these are companies which are actually doing well so I don’t think there is any problem in you saying that there is anything wrong with this companies. The only thing is, at some point of them when there is a value of a Taj Mahal, these will become overvalued and you are going to have to be very prudent. I am looking at that basket so I reconcile that okay, if its not there in my portfolio, then I can live with it. So, some of these companies are in the mid bracket.

If that is the case, then the underperformance that we have seen in the midcaps in the last two years versus the large cap index; do you see the reversing any time soon?

I’m not talking about any index or industries. There’s no point to talk about indexes. There’s no point anywhere, I am not buying index. But I am very confident that I can identify 15-25 companies out of that bracket which will hopefully sail through the sail through these difficult times and when the good times will come, there will be a lot of market participants who will participate in those companies.

This is where all your skill of identifying the right promoter, the right valuation, the right industry and the right blend of everything will come. When I am telling you, there are those opportunities which are available in the markets today.

What is more important to you- earnings visibility or a tactical approach based on valuation mismatches?

I typically look at the perception gap; whatever we see, the reality, is far better than what the market is perceiving. That is when we really start to look at those companies and advise and vice versa. Sometimes it happens that the reality is this and the market is hoping that this is what has happened. So, that is the first place where we start from. So, then we look at the plethora of things whether the upper size or the opportunity is bigger in that sector, whether the management is committed, whether they have their hunger, whether they can really scale through into this environment.

Then you look at the valuation; now these days, the governance has become really important. So, you know that if the company is able to deliver the EPS, whether they’ll get the P/E multiple or not.

Will that also be a function of the sector that the company operates in? I mean, for example, real estate- the entire part of the sector is a part of the mid-cap index. A few bigger players have the edge right now versus some of the smaller players given to them. Metals as a space is noticing a cyclical slowdown so, no matter which company you pick out from that space, it is in a slowdown.

There is a headwind. Like you said, the real estate sector; given what changes that have happened- RERA plus it used to be 8 percent in the overall market cap in 2008. Now, its not even 0.5 percent in the overall market cap. So, at some point of time, it’s a large sector. So, a few companies will do well and this is my point that I see at least 70-80, percent people who are large developers in the real estate sector 10 years back or even non-existent today because of the problems which have happened- the liquidity squeeze, fall in the real estate prices, leverage at the promoter level, leverage at the company level etc. So now, the players who are left out, they will do really well, and the market will recognise it at some point of time that the real estate cannot be 0.25 percent in the overall market capitalisation.

But, it’s a tough trough. When it is going to improve, we don’t know but we know for sure that a few companies that have actually done a good job in the last ten years will continue to do well.

It (real-estate sector) used to be 8 percent in the overall market cap in 2008. Now, its not even 0.5 percent in the overall market cap. So now, the players who are left out, they will do really well, and the market will recognise it at some point of time that the real estate cannot be 0.5 percent in the overall market capitalisation.

If you were to narrow it down to sectoral opportunities, you know that obviously there is an opportunity in the real estate; commercial real estate particularly is superseding residential real estate. But any other sector that you feel that the opportunity and the eco-system is supportive of companies?

It is basically bottom up. There are those opportunities that are there in the PSU basket where some of the Infra companies have got beaten down so badly that they are available very attractively. It doesn’t mean that you go and buy the infra sector. That doesn’t mean that you will go and buy the pharma sector. I think there is a bottom up opportunity where you can clearly see that these companies have done a great job, the promoters are more or less stable, they don’t have a huge leverage, the companies are not leveraged but because of this overall massacre which has happened in the mid cap and the small cap space, even those companies are at a very attractive valuation.

You will find that in those companies. The PSU basket for example, like we are just discussing, suppose one strategic disinvestment happens and if the government is able to go through, then you have so many companies trading at 6-8 percent yield. I don’t think after that is done. it will continue. So, you will find those in banks, you will find those in NBFCs, you will find those in real estate, you will them in pharma, you will find them in PSU basket so, I think it’s a bottom-up situation.

NBFCs have become totally polarised though. Just the handful of 6-7 NBFCs, gold financers and Bajaj finances of the world. This is where much of the market cap that the rest of the market’s erosion faced has been added back.

You will see that over the next one year, it will become clear that some of them which are being perceived today they will not survive. Some of them survive and eventually, create value. Again, you don’t need to be adventurous. All I am saying is, this is not the time to be adventurous because if you are wrong, you may end up losing your entire capital. So, you have to make sure that you watch the overall environment how the things are improving and how the whole stress will be taken out gradually. So, you have to be doing your homework with double or triple the passion that you are used in the past because there is no real margin for error.

For you currently, if you have to take a look at India as a whole and when we are talking about sectors and stocks and valuations look attractive, for India as a whole now, at 17 times, is it favourable enough from a holistic point of view, with earnings that they have been? You may not actually get that full 8 percent EPS benefit in terms of corporate tax cut. In the sense of that, is 17 times reasonable?

No, 17 times is so polarised that there are also companies trading at 60-70 P/E multiple. But there are also companies trading at 4- 6 P/E multiple. So, this is what I am saying. 17 times is not a very compelling multiple but when you go bottom up, you afford to leave out the real expensive ones and when you don’t see the opportunity to really make money in the 3 to 5 year horizon, you’ll see companies which are attractive enough in the large cap basket or within the index.

This is coming out to be a very common thread in the market commentary that the focus shifts to the midcaps where much of the value unlocking is likely to happen.

What has happened is, there is a whole structural change which has happened in the market. There is so much competition that has got eroded in the last two years. In 30 years of my being here, I have not seen this level of dislocation in the corporate sector nor in the market. Obviously, people who are healthy, that leaves them enough room to grow. The companies which are still healthy and have got it painted with the same brush, that is where the opportunity is. Hence, it is more of a bottom stock picker’s market than it has ever been in the past.

In terms of severity of slowdown, from one to ten, what would you rate the current cycle?

I think it was very bad. Its very difficult to put a number but it was bad. You have not seen the kind of slowdown which we saw in two wheelers and metals and across. I think now things are improving; what I hear from the market, things are improving but the market needs to see a lot more from the government and I am very sure that they will take all the necessary steps which are very important. Because, at the end of the day, the government wants to keep its people happy, they want that the economy should grow, how the Prime Minister has come and spoken so many times- he is putting all the efforts which is required to attract foreign capital. So, they are doing all of that.

But when things slow down, it takes time. It takes time. As I told you, this is not necessarily what was intended to be bad. This is what you were trying to do good. This is a side effect of trying to do good.

How soon or how further down the line are we going to rescale those record highs on the index levels?

I think, index wise, it can happen in the next twelve months also but I am telling you one thing very clearly that we are coming out of a very difficult phase. There are ample of opportunities which are available for an investor, if you are a person who has bought today and if you want to review it after 3 months, after 6 months, there’s a chance that you’ll get frustrated that things are not moving.

I have seen so many cycles in my life, we have bought stocks which have not done anything in three years or four years. But the company continued to do well and you have a rocket growth and the stock went up 10 times. So, I am saying that we are in that kind of a phase wherein there are good bargain companies which are available. They are bear-markets survivors and they are available at depressed valuations. So, as an investor who is looking from a 3 to 5-year time horizon, I think there are enough bargain opportunities in the market, and you need not necessarily worry about where the index will go because you don’t buy index. You should worry about what you buy and that should go up.

As an investor who is looking from a 3-5-year time horizon, I think there are enough bargain opportunities in the market, and you need not necessarily worry about where the index will go because you don’t buy index. You should worry about what you buy and that should go up.