Sunil Singhania Sees Opportunities In Beaten Down Mid Caps
Sunil Singhania, founder of Abakkus Asset Manager LLP, is not afraid of investing in mid-cap stocks ahead of the general election even as the year-long rout doesn’t show signs of abating.
“At this time they are being ignored either because no one wants to touch mid caps or anything where there is slightest of doubts,” the veteran portfolio manager told BloombergQuint in an interview. “Companies with market cap of under Rs 5,000 crore are completely being ignored,” he said, adding that he is looking at companies that have been surviving for a long time with a good business model and decent return on equity.
Singhania is focusing on the companies expected to benefit from discretionary spending. India has a young population and as spending habits improve, per capita income and standard of living rise, discretionary spending will come into play, he said.
That comes as the S&P BSE MidCap Index has fallen 6.93 percent in 2019 so far, compared with a 1.9 percent rise in the benchmark Sensex. That only extends the rout which began in 2018 because of changes in mutual fund classification, high crude prices and a credit crisis for non-bank lenders. The MidCap Index tumbled 13.6 percent over the past year while the S&P BSE SmallCap Index plunged 24.45 percent compared with a 6.7 percent advance in the Sensex.
While most market experts agree that results of Lok Sabha polls will not have a long-term effect on the economy or the market, they expect equities to remain volatile for a few months after the elections. More so for mid- or small-cap stocks.
One way to go about selecting small and mid caps is to look at the company’s balance sheet, said Singhania, who recently founded his own asset management firm after managing equities for 15 years as the chief investment officer and global head of equities at Reliance Capital Group. “You need companies where there is no balance sheet stress.”
While the absolute amount of balance sheet stress is not important, the company should have the ability to service its debt comfortably, even in a downturn, he said.
Watch the entire interview here:
Here’s the edited transcript:
How much of an impact could a normal, sedate 2019 or a volatile 2019 for the global markets have on India?
The U.S. as a country cannot grow at 4 percent every year. So, the growth rates are going to come off. Having said that, corporate U.S. is in great shape. The one-year forward PE multiple is 15, which means you are at 6.5-7 percent earnings yield. With interest cost there being 2.6-2.7 percent, there is a great case for equity continuing to do well. Over the last five years we have seen almost $3.5-4 trillion of buybacks by U.S. corporates. My view of equity markets of U.S. is pretty positive, and it is being reflected over the last couple of months post the volatility which we saw October-December. Volatility is the order of the day because of news flow but U.S. market should be decent.
Another interesting thing which has happen is that after 2-3 years of prolonged, constant strengthening—as far as U.S. dollar is concerned, largely because the view was the 10-year G-sec in U.S. will move up to 4 percent and everything was of view on stronger dollar—that view has changed. We have already seen 10-year yield in U.S. reacting from 3.25 to 2.6 percent. The view is that the case for interest rate hike in U.S., at least for near term, is behind us. The dollar, at best, is stable to slightly weak. We are already seeing that leading to flows returning to emerging markets. In the last six weeks’ data, flows in emerging markets from the U.S., both in terms of bond flows and equity flows are very strong. We are seeing that in India also. In past 10-15 days, foreign investments in equity is almost billion dollars in cash. If you add the index futures, you have seen $2-2.5 billion worth of buying over the last 15-20 days.
World is quite stable. News flow relating to China and trade war related will keep on happening. But trade war at margins might help India because lot of companies have started looking at alternative source. So, I am not unduly worried on the global scenario.
What did you make of the RBI’s move of cutting 25 basis points and also reducing the inflation forecast? Does it keep them a room for further cuts in the year to come?
My view has been of a 50 basis points of cut in 2019. May be yesterday’s cut was a little bit premature, but RBI governor might have some reasons for it.
Overall for whole year, 50-basis-point cut is maximum of one should expect.
Inflation in India is always volatile. At the same time, we are in a structural kind of mode where inflation, which used to be 7-8 percent, is now structurally down to 4-5 percent. We should work with inflation range of 4-5 percent as far as India is concerned.
We are running into election period and at that point of time there will be definitely some volatility based on forecast, trends and all which is going to come, and which might impact near-term rupee movements. Over the year, 4-5 percent inflation is something we should live with and may be one more rate cut at max.
For calendar year 2019 and FY20, do you believe that it will be consumption-led story or investment-led story?
India is a country where both will be there hand in hand. Consumption is a structural story. We have a young population. Twenty percent of almost all human beings born in world after Jan. 1, 2000 are Indians and they have still not entered the consumption age. Consumption is a long-term trend in India.
We feel that discretionary consumption will outpace the staples because there is penetration. In terms of discretionary, as aspiration and income levels rise, there will be more move towards discretionary spending.
In terms of capex, there also we are way behind and lot needs to be done. Over the last 1.5 years, the government-led capex has been very strong. So, roads were always a great story. But, metro for example, in 50 cities is either under construction or in final stage of being implemented. We have 75 new airports which have come up or will come up in next 6-12 months. We have big freight corridors coming up. In Bombay itself, almost Rs 2 lakh crore of infrastructure are already on ground—Rs 1 lakh crore of metro work and now we have coastal road, we have Mumbai-Ahmedabad bullet train, we have Mumbai-Nagpur expressway. So, it is going to be government-led capex to begin with.
In terms of corporate capex, for example on metal front, particularly on steel, the companies which are doing well have ready-made assets to acquire. So, right now their energy and capital are going on acquiring those assets. Once those assets are acquired, consummated, then the next phase of expansion will start after couple of years.
Same thing will happen in power. Right now, we have a lot of spare capacity available which can be acquired. So, companies want to increase their exposure. So, generation capacity will take some time to come up.
In renewals, there is a huge capex. But one sector of power where there is likelihood of good amount of capital expenditure is distribution side. And there we are seeing privatisation of large town and cities and good interest there.
On city gas distribution, we have seen 60 cities being allotted to private companies. Fifty more cities are going to be allotted. Every city brings around Rs 1,000-1,500 crore of capex. In bits and pieces, there is lot of infrastructure-led capex which look on horizon.
In terms of private capex, in smaller sectors like ethanol, chemical, paper, to some extent cement, pharma, we are seeing good capex taking place. The large sectors, which are metal and power, there you have existing capacity. So, once they are acquired and put to use only then that segment will start to see some capex.
One pocket where there was valuation pull back was autos. What are your thoughts? Do these companies revert to mean at some point in sales and valuations or it is difficult to predict it right now?
For autos, you can’t put them all in one basket. Two-wheelers are well penetrated. So, from here on, to expect significant volume increase year by year is tough. It is decent business with good cash flows. Maybe instead of growth sector, the two-wheeler segment will start to trade as a value sector, which has already started. Companies are trading, on an average, 15-16 PE.
On four-wheeler side, there is headwinds in terms of cost pressure and demand. There is still a lot of room there. We have to see at what values you have to buy those companies. But there is some opportunity there.
The biggest opportunity in the commercial vehicle segment is that there is a view that sales have slowed down. My view is if you are bullish on infrastructure growth, economic growth then this segment cannot be ignored.
So, some of the companies may have corrected meaningfully and we see value in that particular segment as far as auto is concern.
Auto ancillaries is going to be more tricky because there is threat of electric vehicles coming up, specifically on passenger side. Lot of these auto ancillary companies might see their business scaled down significantly in case that happens. My view could be more inclined to commercial vehicles segment than the auto pack.
The auto space has seen a retreat. The other space which have been buoyant and giving to shareholders is technology stocks and IT pack. All the large cap names have rebooted robust numbers. Is this the sign of things to come? They have been talking about maintaining guidance at the upper end. So, it doesn’t look all that bad.
IT is completely export-oriented sector. The U.S. economy has been growing well. Last year, it has grown 4 percent. This year too there is going to be positive growth. Technology has become the way of life. So, every company has to spend and keep itself up there as far as technology is concerned. That is an opportunity as far as services company in India is concerned.
The other thing which Indian IT company has successfully done is now started to respect return-on-equity distribution. So, in the last 2-3 years, almost all IT companies who have significant cash balances either resort to large dividends or buybacks or both. That is ensured that capital is returned to shareholders, the return-on-equity is maintained and that is also aided in their valuation. So, it is combination of somewhat better than market outlook as far as business is concerned and also discipline in terms of not hoarding too much cash.
As we move forward, the sector looks decent. There are pockets, specifically, in smaller IT companies where valuations are in your favor and it makes sense to invest in those companies from a couple of years perspective. We are sure that companies can grow 10-11 percent as far as volume is concerned, may be slightly more in terms of their profits. But the cash conversion and distribution will ensure that decent returns can be made in this sector.