Corrections As Buying Opportunities
What kind of correction would offer an opportunity to make fresh investments? And what should a retail investor do right now?
For retail investors, we are at valuations where they need to take a 3-5-year view. From a very secular perspective, this is not a good time to book profits. We are in the early stages of a multi-year bull market. To my mind, we are almost in mid 2004 of the 2002-2008 bull market cycle. It’s not 2002, so we are not cheap. We were that cheap in 2013, but that’s when the macroeconomic condition was the worst. Typically, when you have weak macro, there is a massive risk off and that’s when the markets are at the bottom. When things improve, the PEs expand and then earnings catch on. Then you have a virtuous circle of earnings coming in and PEs correcting.
We are still at the early stages of that bull market cycle. This is not the time to take money off the table.
Unless we see 2-4 years of solid compounding of earnings growth and on top of that you see high PEs, that’s the time we should think of taking money off the table and not before that. Currently, you should look at every correction to look at adding positions. Whether the correction is a shallow 2-3 percent or a deeper 5-7 percent, is anybody’s guess. I don’t think we are at a stage where we should be thinking of booking profits if you are a long-term investor.
Opportunities For The Retail Investor
Even at current valuations, where does a retail investor put money in?
For the retail investor, the trend which is going well is putting money in systematically, put money in diversified mutual funds so that you could get exposure to broad sectors of the economy. There are several good mutual funds which have very good long-term track record. If you are a very savvy investor, you could come to a portfolio manager like us where we create a compact portfolio of high conviction ideas for the long term. The way we are looking at markets right now is that there are certain secular themes which everybody likes - private banks, NBFCs, auto companies and a few select high quality companies which continue to compound on the consumer side. So, every long-term portfolio will have some exposure to these sectors. But at the same time, you should now start looking at companies where the balance sheets are good, but where the revenue traction was not there until now. And you believe that with some of these reforms and growth coming back, traction would also start to come in, and those are not yet reflected in their valuations. I am not talking about very leveraged companies or companies which had broken business models. There are several companies which haven’t done as great in the stock market over the last 2-3 years because the rally has been concentrated in a handful of companies. So you start building your positions in some of those companies - the bucket were the balance sheet is good but the P&L was still struggling, and you believe that the P&L will start to grow. Once that growth comes in, there is operating leverage and the market recognises it and you start getting the benefits of valuation. You have to play a little contrarian, not just for the sake of being contrarian but you have to start looking at domestic-oriented sectors where you think the growth in infrastructure or volume growth will drive this companies. Then, there are at least 2-3 large sectors which are going through tough problems. You will find opportunities in the next six months to be the contrarian there. Pharma stocks have corrected almost 50 percent from their peaks. IT hasn’t been doing well. It’s not that this is going to be the situation for the next 3-5 years but this is a temporary blip. It might continue for couple of quarters. But it will also give you an opportunity to buy into some of these names. You take a lot of this and combined it into a portfolio and you still have opportunities to make more money. The problem is so far the visibility is restricted to a very few companies. That’s why all the money is chasing those names and those valuations have become expensive in the marketplace.
NBFCs: More Upside Left?
Do you still believe the growth momentum, the current valuations and the asset quality trends for the consumer-oriented NBFCs can continue?
You have to differentiate between one unsecured lender and another unsecured lender. While valuations are very expensive now and I can’t argue that it’s a cheap stock anymore. But I wouldn’t worry on their credit underwriting standards. It was because their credit underwriting standards were so strong, that they are where they are today. That’s the reason why markets are giving them high price-to-book. If they had higher gross NPAs as many NBFCs...Mahindra & Mahindra [Financial Services] has almost reached double digit of 8-9 percent gross NPA, many public sector banks had reached there, several specialised NBFCs also have high gross NPAs. They have never gone there. Their systems, processes, credit underwritings standards are a class apart. We have to also understand the absolute size of the balance sheets. No longer are they as they were five years ago with just one or two revenue streams. They have several revenue streams. They have diversified their book substantially. Secondly, if you study their business model, they don’t give unsecured loans to anybody or everybody. It’s a cross sell to an existing customer. They understand the customer, have his or her credit history. Only when they are comfortable with the customer, do they give unsecured loans. And thirdly, the absolute size is still very small. For example, HDFC Bank’s balance sheet size is Rs 8.5-9 lakh crore. This year the asset size of Bajaj Finance is going to be Rs 65,000-70,000 crore. It’s less than one-tenth. And this is not a direct comparison but you are still a sub-Rs 1 lakh crore balance sheet size. So, there’s enough room to grow and there can be several Bajaj Finances which can come in. But the whole idea is not about secured lending versus unsecured lending. It’s about what your credit underwriting standards and processes are. You could still make money in unsecured book provided you run that business very carefully. On that front, I am confident about Bajaj Finance. But valuations are a different issue. One could argue that it’s very richly valued.
The Big Bets
Which companies do you think are likely to be the big leaders of tomorrow?
The recent rally in the Nifty or the Sensex is driven by sectors where there is gross under-ownership. For example, I don’t think people own as much of oil and gas as they own a HDFC Bank, for example. People don’t own so many metal stocks because it’s a cyclical industry. And this does happen in markets that there may be parts of the market, which you don’t own, which go up. That creates short-term pain for investors like us who don’t invest in cyclical businesses.
What will lead the next cycle? Financials will lead because they are a great proxy for growth. Whether you are giving a housing mortgage or a consumer loan or an unsecured loan. The only part of the market that is not growing is corporate credit which may take some time to grow. The FMCG sector could also be one of the potential sectors which could lead because they will be one of the big beneficiaries of GST. With two good monsoons, and over the next 12-18 months the government is likely to pump money into the economy, especially at the bottom of the pyramid, that’s likely to drive consumption in rural and urban areas. Similarly, autos should do well. I think cement will do well because there will be infrastructure spending on one side and housing growth on the other side. These are some of the sectors that will lead.
PSU banks and capital goods will take a little time before they can join the party. Those are the late cycle movers. PSU banks because of the gross NPA issues. But SBI can be an exception as they have raised capital and they are in a far better position. PSU banks, capital goods and large infra companies might join the party later on as the economy picks up in the next few quarters and years.
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