The post-election outcome rally was short-lived. Are government cues going to be enough for providing the near-term fillip to the markets? Will the budget or any key reforms or financial sector reforms drive things going ahead?
I would look at it the other way. Some desperate measures are required to stem a downside rather than push the rally forward, given the state of the financial sector. We are seeing the ramifications of the stress on the financial sector on the real economy. In the last couple of quarters, companies across sectors, particularly in consumption (both discretionary and staples) have reported decline in growth levels. There is a clear slowdown and a lot of this has to do with the sort of liquidity issues faced by the NBFC sector.
The NBFC sector provides the greasing to the economy to roll on in areas where the banking system does not participate, particularly in the supply chain distributors. Wholesalers tend to borrow to fund their inventory. What we are hearing from companies is clearly those inventory takeoffs have come off and a lot of that is attributed to the lack of liquidity in the system. And that won’t be helped unless and until we stem that rot and get the NBFCs back to lending.
There are good NBFCs and bad NBFCs which is where the task is much harder than what I make it out to be. I am sure the RBI and the finance ministry together can figure out the problem where at least good assets are being allowed liquidity flow into so that working capital financing comes back and the economy scales back to some level of growth. We can talk about structural reforms perhaps three months out or six months out, given the sort of mandate they have got. I am sure they are working on some but the near term need is to fix the liquidity in the system.
Is that easier said than done?
I can make it sound simpler but yes, it is not that easy. You will have to take some tough measures. Some companies will have to take a hit, some segments of the market, particularly equity holders in some NBFCs, some bond holders and mutual funds who have lent to these NBFCs will also have to take write-downs. But that seems like the only way out.
Is the selling in Yes Bank, Dewan Housing or for that matter some of these stocks where there is visible stress overdone now and does it make sense now to buy them?
It depends. There are certain types of buyers for whom it might make sense. These are called distress buyers. It is not made for every buyer in the market. You should know your skills when you are buying assets. These are assets which require specific appraisal skills which are quite sophisticated. It is a very sophisticated segment of the investor community which will look at such assets. For those who are looking to buy into growth stories, it is best to hold off from looking at these assets, wait for the dust to settle down, wait for the recapitalisation and wait for any sort of management change to happen, make an assessment of the future growth prospects and make a bet.
What are you buying in this market?
It is still the same stories; there has been only one engine driving this economy in the last several years — except for the period between 2003 and 2007 — consumption and naturally so. It is the demographics which play into that. Having said that, consumption has seen a bit of a slowdown. It’s partly cyclical and the reasons I talked about in terms of working capital challenges in the sector are also structural in the sense job growth and income generation have not kept pace as much as valuations would suggest. But still that is really the only story in town.
If you believe this government will take some tough measures in terms of putting through the investment cycle coming through that is resulting in job creation, income generation and disposable incomes going up, consumption still remains the only story to play. The best part is that there are some good companies in this sector to back.
Alongside that, private sector banks are again going to benefit from the problems in the financial sector. We used to talk about the stress in the PSU banking system which allows private sector banks to take market share. Now, even the NBFC space is vacated and that gives a clear growth runway for some of the better capitalised private sector banks which have access to low cost deposits to run their loan book growth, without having to take significant risk. Those are two obvious bets in my view.
Do you feel that some kind of policy measures are required on real estate and NBFCs to streamline the system and reduce the vulnerability? Are you seeing any pickup in real estate. How bad is the situation there?
Significant policy measures were brought into real estate — starting with demonetisation and followed by GST and RERA. These are structural changes which are very good from a long-term perspective. But people should remember that it will come with short-term pain which is what we are witnessing. The only problem is that short-term pain is rubbing off on other sectors, particularly the lenders, who have lent to these developers and the mutual funds who have lent to these NBFCs and that is a collateral damage that we will have to take.
I do not think the government can do anything to push the real estate, the residential unit sales in the short term. We are seeing a gradual improvement in affordability, prices have remained stable or have taken a knock but the gap was significant say four, five years ago.
Until and unless we see that gap eroding completely and the end users coming back to buying there, you need that job creation and income generation to come through as well. Eventually it will happen. Indians will need homes to live in so it will come back but I do not think there is any policy measure that the government can take to make the significant number of unsold homes become affordable overnight.
For the next six 12 months, would you like to make a portfolio which only is not A quality but AAA plus — Bajaj Finance, HDFC, HDFC Bank or TCS?
I do not know if it holds for the next 12 months but that is exactly what we have been doing for several years now and that is what you should do.
Bajaj Finance and Titan are at all-time highs. TCS is at an all-time high, HDFC Bank is almost there. So, pick up like the top five names and then just sit tight for the next five years and you are guaranteed if not 20% return, 15% return?
Absolutely. When you say that prices are at all-time high, you should also remember their earnings are also at all-time high. The bottom line is you pick stocks where valuations are at all -time highs. In my view, if the economy is getting concentrated in a handful of names, the growth runway for these companies will be that much longer. It is not just growth for next two, three years, you reckon these companies will grow for the next 10, 20 years.
It is very difficult for the 20-year growth to get priced into PE multiples or price to book multiples which we literally look at one year forward earnings or one year forward price to book. If you have the confidence that these companies will continue to lead their sectors for the next 10, 20 years, the market is still not adequately pricing them.
While we have been talking about those handful of stocks, it is clear that everyone is trying to be a little cautious. What is the near-term fallout that you are anticipating? Do you see smaller NBFCs getting gobbled up? Do you see impact on debt funds with exposure?
We are seeing that happen and it will only get worse if it is not fixed soon. Urgency is the need of the hour and you need to get some measures where you can separate the bad assets and the good assets before the impact on the real economy becomes much more dire. We are already seeing that.
Like I said, over the last couple of quarters, we have heard some of these quality companies reporting slowdown in sales. It affects everybody in the economy because supply chains get hit when liquidity is pulled out. The collateral damage can be everywhere, not just the NBFCs or the mutual funds. Even good quality companies can suffer in terms of growth slowdown.