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This article is more than 3 year old.

Market cap to GDP is still not back to February 2016 levels, says expert

Mini

From  liquidity issues that plagued the non-banking financial companies (NBFCs) to  rising crude prices and high interest in the US that exerted pressure on the local currency, the domestic market has been hit heavily.

Market cap to GDP is still not back to February 2016 levels, says expert
The festive season comes after a period which saw domestic and global factors battering stocks across all sectors at home in the last few months. From  liquidity issues that plagued the non-banking financial companies (NBFCs) to  rising crude prices and high interest in the US that exerted pressure on the local currency, the domestic market has been hit heavily.
Here, Akash Prakash, Director & CEO, Amansa Capital along with
Ridham Desai, Head-India Equity & Research, Morgan Stanley and
Raamdeo Agrawal, Co-Founder, Motilal Oswal Financial Services discuss whether the festive season could bring back  cheer to the Indian market.
Q: How does it feel, Samvat to Samvat, we saw the index go all the way up to 11800 and now 10500 but back from the lows – does it feel we are fairly valued now?
Prakash: My view is a little more cautious and other people in the sense that the market was a little ahead of itself last year – the valuations in the midcaps and smallcaps specifically were quite extended – so this correction which we are undergoing or has completed is much needed and it has brought valuations back down to a more reasonable level.
But I still feel that and I have been saying this for some time that the scope for PE expansion in India is over and you now need to see earnings growth. Till we get a decisive visibility and demonstration of earnings growth in India, I don’t see how the market will go up significantly.
So we get the earnings growth the market will do very well but if we don’t get the earnings growth, the market will just hang around here. So the market will wait to see that.
Q: I take the earnings growth bit but you said more reasonable – is it reasonable enough for you to buy?
Prakash: Well specific stocks yes because there has been significant damage in the midcaps and smallcaps space specifically and stocks are down 30-40 percent. So there are specific ones which look interesting.
Broad market as a whole, I don’t think is cheap is that sense, it is a very stock specific market. This is not 2013 where broad market was cheap and one could have bought anything. I don’t think this is anywhere near that level of being cheap.
Desai: To take forward Akash’s point the market is not even as cheap as February 2016, forget 2013 – in 2013 the market became very cheap. In terms of valuations a very simple metric is market cap to GDP is still not back to February 2016 levels.
So what we saw was a ferocious 2017 and that is why we felt 2018 was so bad but we have not seen that type of price damage that we saw in February 2016.
Q: So market is about extremes – we had one extreme perhaps at that point and the other extreme somewhere around February or March of this year. Has it corrected enough now for you to constructively look at the market in terms of building portfolios.
Desai: I feel so because I think the earnings cycle is turning and I hope these are not last famous words because we have been expecting this for two years now and it has been belying us for that long. It has been very complicated and has defied my expectations.
The fact is if you look out three years, profit share in GDP is at all-time lows, mean reversion is due anytime. It hasn’t come thus far, I don’t want to give up on that call, it will come and when it comes and I think when we look back - stock markets may not have been that expensive. While they do look rich on PE multiple, the fact is earnings are depressed. So I tend to look at price to book on the index level and that is better guide to time the market and it is currently at 2.8 times book which compares with historical average of 3.2, which compares with the troughs of 2.2 in 1997, 2003, 2008, 2009 and it did not come to 2.2 in 2013 but came quite close. So, we are not in that type of crisis situation these were really big crisis for us to go back to 2.2. There is a line in the sand there and in don’t think it falls much below that. So, 2.8 is not a bad level for me to engage in stocks with clarity that there are some risks out there which can cause valuations to come off but they are not any more at levels which frighten me.
Last quarter, last year midcap valuations were out of the park and were just not justifiable and now they look okay.
Q: Just to extend that argument – in the month of September perhaps we went through capitulation – this big stocks also started to fall. In the first two weeks of October we saw a bit of a despair and the market refused to rally even on good news and it was selling even on good news. The last couple of weeks the way the market has reacted to bad news in certain cases has that given you confidence that perhaps it is now willing to look forward and the worst of damage maybe well and truly behind us?
Agrawal. Clearly after 1500-1700 point correction lot of this froth which was there more in midcaps and smallcaps and even in some largercaps 20-25 percent have been chopped off from their all-time high positions. So to that extent good amount of correction has happened.
One of the factor what Akash and Ridham said perfectly is expecting earnings growth to happen which has been quite elusive for last four years.
One of the factor which has happened in last one year or last three years post 2014 is the massive domestic inflows whether it is because of financialisation or whether because nobody is going into real estate or gold, so everybody put the money in bank and MF is good, so we have Rs 2.5 lakh crore flow which his unprecedented. It is like almost 1.5 percent of GDP, which came into MFs only and what they did in other things like PMS etc that could be another 1.5 percent. So some serious amount of money came into the market looking at the rearview performance. But earnings just defied, they did not come and so market stretched, the PE multiples of the market broadly went from 17-18 PE multiple to 30 PE multiple because earnings are same at the aggregate level.
So the moment the flow for some reason has slowed down now and that decline in the flow is not able to sustain the market at that level. When all this credit crisis happened in last September-October. Half the problem was what happened to the credit rating but the real problem was when people wanted to sell there were no buyers because there is no flow.
That vacuum of lack of buying in those counters, slightly Rs 5- 7 lower that created then flow fell through and the stock fell by 10-20 percent but there were no takers.
So, how do you repair this situation? My sense is that it can be repaired by only money – either foreigners come in or domestics come in again. Domestics have not gone out, they don’t have exit to any other place. So we hope that flows will again build up. Therefore, a lot is dependent on how the inflow into domestics happen because the FIIs are still selling. So it is all about the flow right now and valuations are not yet dirt cheap because the total market cap to total profit is still at 30 times.
Desai: So just on Agrawal’s point- you will get the good news. October was a spectacular month for flows. The domestic MF buying in the markets was all-time high, it was up 50 percent over the month of September and it is not for no reason that stocks have rallied because there is lot of domestic buying.
Foreigners sold more than they had done in last ten years and worst since January 2008. Net institutional activity was negative for the first time in 38 months because foreign selling exceeded domestic buying but domestic buying was up a lot month on month. So when the MF number comes, I think it will be very strong.
Q: Since you have been speaking of earnings and valuations. For the last four years the joke is second half we will see earnings and it has belied, how is it now - you have seen halfway through the earnings season, does it look like this time is different?
Prakash: Earnings will disappoint this year as well. If you look at the earnings expectations of the people who are bullish, it was 15 -20 percent earnings growth for FY19 and we are not going to get 15-20 percent, there is no question about that, it would be 7-10 percent at best, depending whether you classify PSU banks whatever number you look at, so one is that it is going to disappoint. It is definitely going to undershoot what peoples’ bullish expectations were.
I agree with Ridham that the argument for mean reversion is very strong in a sense that profit to GDP is around 3-3.1-3.2 percent, the long-term average is near 5-6 percent, so we are way below trend.
But the only thing is that this lack of earnings coming through is now 5-6 years, so if there is something structural I don’t know. All of us need to spend time and figure out why this is happening because it cannot be just cyclical now sine it is 5-6 years is long to be a cyclical problem. So is there something structural is the question.
Q: One argument could be that four years ago we were counting even power plants and stuff like that as adding to GDP – now all that has got flushed out?
Prakash: Should have been washed out. I agree with you and Ridham and I also remain hopeful on earnings but my note of caution is based on the fact that I have been hopeful for two years and have been wrong.
My other concern is that FY20, there is the potential risk of the economy slowing down – because you have one, post-election if the government is pushing hell for leather in terms of spending right now, you may have pullback in FY20 possibly due to that.
Second, the impact of NBFCs crisis would be felt 6 months from now in the sense that the NBFCs will slowdown lending and there will be reduced credit flows into the economy. Third is that the global economy is going to slow next year because US is unsustainable running at 4-4.5 percent and so the rest of the world will slow as well.
Therefore, I don’t see a case for the Indian GDP accelerating next year, I hope I am wrong and maybe if oil prices collapse something could change but even if assume that it does not accelerate but remains flattish, then the picture on earnings the same question – where will the earnings come from.
I agree with Ridham that mathematically it makes sense, reversion to the mean argument makes sense but we have to sit back and accept that we have been making this arguments for four years and it has not happened. However, that does not mean it will not happen but we need to face the reality that there is something happening which we do not understand. I don’t know, I am just putting it out there.
Q: Any of you willing to stick your neck out and say that 10,000 is the bottom for the market?
Desai: There is no way you can stick your neck out on that. I can’t count the number of things that can go wrong in the next four weeks.
Q: What is your bear case scenario?
Desai: The bear case is around that level but we were staring at that bear case and we were staring at it actually getting violated two weeks ago. It came back from there but that doesn’t mean it cannot go back and cannot go back below that.
My view is that for the large part of the people who engage in equities it is not fruitful to try and time this because none of us know what the bottom is. I think the share prices have corrected reasonably from here from the top, especially smallcaps and midcaps and I think they warrant attention. I think they warrant part of your cash. You got to put that to work and if they come down more, if the election results are unfavourable to the market and the market wants to sell-off another 1000-points on the Nifty then you put more to work.
I have always held this belief that you keep cash on the sidelines, you are never fully invested because there are always an opportunity to put that to work. So you will get that opportunity.
I would approach it like that rather than try and second guess what the bottom of the Nifty is and whether it can go down further, it can.
Q: If Ridham says he has second guessed it emboldens others to put their money
Desai: I go wrong 50 percent of the time, so let us not go down that path.
Q: What has been the earnings tally so far – we got L&T earnings, Cummins, Bajaj Auto – there were a many good numbers- Do you think earnings are picking up?
Agrawal: For the last 4 years or maybe 8-10 years the capex cycle has not picked up more from the private sector side – like putting up one more cement plant, a steel plant – you are busy with liquidation process or IBC process. So now all these plants once it is settled – immediately, actually the guys who are buying will not only spruce it up they will put up few more million tonnes into existing site.
One of the attraction for this entire process is that they are getting large pieces of land and all the permissions so from 5 million tonnes in Bhushan they can go to 10 million tonnes etc, so that type of capex will. So that kind of capex will start and the cycle is right now doing well. So it can attract a lot of new capex. Same way in cement, once the capacity utilisation goes up.
Real estate one of the most disappointing segment right now, it is the largest industry of the country and also the world. The sector is not in a great shape in India, somehow demand and total excess capacity or excess construction which has happened and the condition of developers, they are not too good. So even that to pick up. I don’t know what will kick that off at some point in time. Most problem for the sector is on the residence side, not on commercial side.
Now that tide is turning for the commercial space in Mumbai and other places. I hope real estate and the capex cycle for the infrastructure, as well as private sector, once that happens, a lot of businesses which are lying flat or negative that should start perking up and that is visible in L&T’s orderbook position.
Second is what do you think this entire PSU bank pack, which is actually imparting Rs 70000-80000 crore of negative profit into the total profit. If that can be at least zero and then actually they have potential to earn Rs 70000-80000 crore. So that can change. Almost delta of Rs 2 lakh crore in aggregate profit about Rs 4 lakh crore.
Q: The two cheerleaders of our markets, the big rally that we had, were consumption, and the piece that finances this consumption-- banks and NBFCs. There is a lot of debate right now on whether that piece can be repaired or is it just going to fall off and it was just a bit of a flash in the pan, the NBFC space that is?
Prakash: Two, three points; I think one is the NBFC space, there will be some shakeout in the sense that I think valuations had gone to an extreme there. If you look at the last 5 years, there was phenomenal stock market performance across the NBFC space, I think some of that is obviously unsustainable.
The good NBFCs, the Bajaj Finance’s, the M&M Finance’s, I think they are not going to have a problem. There will be 6 months of growth slowdown and they will be back and I do not think there is an issue at all. However, there will be a whole bunch of smaller, maybe not necessarily listed NBFCs, or some housing finance companies (HFCs) which are more challenged and where growth will definitely slowdown significantly. There I think there will be a genuine valuation correction.
I think also what is happening now is an unambiguous positive for the private sector banks because you are going to see at the minimum increased deposit flow to the extent that money comes out of mutual funds or debt and equity funds and it will go in the bank deposits. So that improves the liquidity which has been the biggest constraint for the private sector banks. Second is your biggest competitor on the asset side which is NBFCs, is weakened.
So, I think the financial services space is still a good space to be in. I think there will be some reallocation of performance, in the sense I personally believe that corporate banks are going to come back partly because FY19 should be the last year of very heavy provisioning for the ICICI’s, the Axis, the big private sector corporate banks. In fact Morgan Stanley, Anil Agarwal has a very bullish call which I agree with totally on that space.
So, financial services I like, but I do not think NBFCs are going to be the market leaders like what they have been for the last 4-5 years. I think that was a unique period in time where you had very good macro, very low interest rates, very easy liquidity, significant flow into debt and liquid mutual funds allowing access to debt funds which the NBFCs did not have, and a huge runway space left open because the PSU banks cannot lend because of prompt corrective action (PCA) and stuff like that. I think in that environment the NBFCs were able to fund and grow at 30-35 percent per annum for 5 years.
I think investors and the management of the NBFCs themselves have extrapolated this going forward, I do not think that is sustainable. The whole pack is not going to go at 30-35 percent, one or two may, and what you are seeing is a valuation correction which I think is permanent for a lot of NBFCs. They may have got oversold and they will bounce back, but I do not think the NBFC space is going back to 3.5-4 times book, the ones which are impacted. The Bajaj may remain at a higher level because they are slightly different in the way they are, but the average NBFC which was trading at 3-3.5 times book, the average NBFC which was being quoted by private equity fund, people were leaving their jobs and raising money and getting 3 times book, that type of stuff is not sustainable. So that is not going to continue. So I think the leadership is going to change in financial services.
Q: To what?
Desai: I do not think Akash is arguing that financial services stop performing. He cited our research, so I think corporate banks are looking very sweet. Most of them are trading at sub 1 time book, they are sitting on very high level of provisioning. Not all the PSU banks, but the private sector corporate banks have enough capital, deposits are actually in good shape, their CASA ratios have grown in the past 5 years and all of them have seen management changes. So, I think we are set up for strong performance. I do not think there is anywhere else to hunt.
I am also bullish on cyclical consumption. I think consumption, cyclical i.e. discretionary consumption like automobiles, I think will do very well, especially rural India.
Q: This Maruti Suzuki performance is a temporary aberration you think?
Desai: I am distinguishing here between urban and rural. I think DBT has been an enormous success. We are annualizing Rs 2 lakh crore of transfers, this is a massive change for India because hitherto the government was distributing subsidy in kind. So it was deciding for the poor person what he has to get cheap. So you all get cheap rice, I will give cheap rice, but now the government is transferring in large part cash into their bank accounts.
The power of the decision has gone to the lower strata of society and I think we will get surprised the manner in which they may end up spending – like education, entertainment, vehicles, these are all productivity enhancing tools that they have now been empowered with which they will end up exercising. So some of it may get wasted, but a large part of it I think will find itself into the real economy.
So I am bullish on cyclical consumption over staples, rural over urban, corporate banks I think will do very well, I am less constructive on IT -- I think it is done, fully valued now, currency tailwind is I think behind us, relative growth looks favourable for domestic over global. So, I think you want to be in domestic sectors which have got a bit of cyclical tinge to it.
Q: I was under the impression you guys will not be so bullish on consumer because of the Larsen story?
Desai: I am very bullish on industrials. I think Raamdeo made a very important point which we missed out in the earlier discussion, Akash raised this issue, the reason why margins are depressed i.e. profit share in GDP is low is because the investment rate is low. The country’s aggregate investment rate is running at about 15 percent versus a peak of 28 percent. When we go from 15 percent to 20 percent, corporate profits will be very different.
The single factor that has depressed profits, is low investment rate. So, the fact that private sector investments could pick up post elections, I think could be a big kicker for earnings. State capex is very strong, so that is reflecting in the order books of industrials and that I think will feed into a bit of growth over the next few months.
Q: While we want to talk about this comeback of Indian equities, the fact is, if you see this month or this year, our market performance is absolutely in-line with the MSCI emerging market and MSCI Asia Ex- Japan. Month-to-date, year-to-date, both are absolutely mirror image of what the emerging markets and global markets have done. We had Akash making some points on global markets, you have also seen so many of these cycles, in terms of the move, the emerging market versus US markets, are you sensing some kind of decoupling now over the last one month or so and do you think perhaps even some FII money will start to come into the emerging market and Indian markets?
Agrawal: Unless we see the money, at least unless we see some kind of trend that 15-20 days continuously they are buying in, I would think that they will continue what they are doing. I do not think anybody has any extra insight on that. Till the money starts coming, you cannot say that it will come, there is no guarantee.
Even for the domestic investors, howsoever close we are, we cannot say that money flow which has reduced by at least 50-60 percent, will that go back. It can go back because money is sitting on the side, it has not gone into real estate or something else. So risk appetite has gone down and even recent performance has not been great. So, all the portfolios which came in last year, they are all in negative. Once your performance is negative, then generally the public who have come first time, they are not very encouraged to again put up money on top of it.
So you need extra reason, say like political development, oil tumbling to USD 60 per barrel, maybe capex picking up big time, employment generating big time, or performance in the market. However, performance in the market will come only because of two things, one is buying by any other segments, or accelerated earnings growth. Both are looking very elusive right now.
Q: Some people speak of an algorithm trade, we were deserted when crude went to USD 86 per barrel and you saw as you said record outflows in that month. However, with crude receding, you could see the algorithm reversing. What is the in-house view at Morgan Stanley and do you think that USD 86 per barrel was always unsustainable and therefore we could expect shift in flows?
Desai: Firstly, on the emerging market thing, our emerging market strategist has been cautious on EM and a lot of EM indices have hit his target price more recently. So they have all fallen as much as they have and I think Anuj asked this question on decoupling which is I think a relevant one because the SPX relative to EM outperformance has been at record highs and is now topping out seemingly. So, EM has started outperforming. So, there could be a shift that may be underway, we do not know. It is still a market in transition.
As far as oil is concerned, the house view is that we are actually bullish on oil. However, there has been breaking news overnight which we cannot ignore. For all these weeks, the market thought Iran was not in the market and now suddenly Iran is back in the market. So the supply dynamics has changed. Also a lot of US production has come back as a consequence of higher oil prices. So suddenly the supply-demand dynamic looks different. If Akash is right and if global growth is slowing down, then again that puts pressure on oil. So, this could just be a sweeter space for India in that sense. However, we will have to wait and watch and see how it pans out.
Q: In election year there is also a possibility of self-goals. We saw perhaps one playout with the oil marketing companies and the fact that government said Rs 1 you will have to absorb and we saw the kind of market capitalization damage. Is there a risk that as we move into the big state elections and of course general election, perhaps something big like a big farm loan waiver or something other could damage the overall macros once again?
Prakash: Obviously that risk does exist, but I do not think that there is anything on the horizon which could be of the magnitude which could dampen or cause a fiscal shock of the extent which would really damage the markets. This government till now has been reasonably disciplined in terms of their fiscal outlook, one thing they have done is by and large met their fiscal targets and goals. Could there be some slippage on the fiscal deficit this year? Yes, it is a possible, it is an election year, GST is the first full year, and transition is possible.
So I think people will kind of look through that, if it is 20-30 basis points, I do not think people are going to fret too much about that. I do not think this it is in the DNA of this government to do some doll out or some bailout or something of lakhs of crore which is what you would need to really shake market wisdom, I do not think that is likely. However, politics I have absolutely zero understanding of critical dimensions and compulsions of elected governments.
So I would not put it past them, but I would think the odds of them doing something on a scale which would scare market participants, is very low. It has to be really large scale, you have to blow the deficit by let us about 1 percent of GDP which is more than Rs 1.5-2 lakh crore. That does not look and what capacity does the government have to spend Rs 1.5-2 lakh crore in a matter of 3-4 months? Even if the government wants, they cannot spend it.
Q: There is a fiscal math that is not adding up. Only for 1 month we got GST at Rs 1 trillion. The asking rate is 1.1 per month. So we are short by maybe Rs 50,000 crore.
Prakash: I think that people are expecting now.
Q: That is the preface to the question. Therefore this institutional shock, putting your hand in the RBI capital. That itself may not disturb, but if that ends in a showdown which was averted, but if that showdown were to happen again?
Prakash: I agree with that.
Q: Will that be very bad?
Prakash: Any institutional shock?
Q: If the governor resigns?
Prakash: Of course, because I think in any market, any environment where you have two very respected institutions like the RBI and the finance ministry at loggerheads and if you playout your scenario that god forbid that it leads to someone resigning, I think that is an unambiguous negative because people start questioning autonomy, people start questioning the type of people who are in government, what is going on and stuff like that. It will definitely spook people. I do not think you can paint any scenario where this is not a negative if this were to go in the direction you are saying.
Q: There are those in Delhi who have even tweeted to me today that if oil is at USD 72 per barrel and the rupee goes to USD 72, then those are the fundamentals that matter, showdown or a resignation can be stomached.
Prakash: No. Institutional credibility takes years and years to build. Whether oil is USD 72 or oil USD 85 or oil is USD 35, these are transient. Rupee USD 72 is a transient. I do not think you can trade off a price of oil and a price of rupee which is a particular point in time with long term institutional conventions, credibility, the way you approach problems, the way you discuss and consult.
Q: This argument is more that we are overstating the importance of this event. You don’t think so, you think it can have a big damaging impact?
Agrawal: Whenever you disturb any institution, there could be 10 pluses but this minus will remain minus. What is wrong is wrong. You cannot compensate that you got very good in maths but you failed in English. You remain failed in that particular aspect of it and in many jobs you cannot apply if you have failed in English, so it is that kind of thing.
Q: The one stock which has come back is Divi’s Lab for example, from last year’s big problems, went to 52 week lows and the recovery to all-time highs once again. Lot of people are asking can the entire pharma sector do the same. There is bit of a flash in the pan move that we have seen in some names like Aurobindo Pharma, Sun Pharma but still way off their highs. So, can something like Divi’s Lab repeat with the entire sector you think?
Agrawal: Yes quite possible. The right to win for the entire sector in the global market place in generics there is no alternative to India. So, whichever company gets its strategy right, products right, rollouts right or permissions right, they have the right to win in big way.
Indians are very smart, all the companies in all the fields, they are winning very slowly. You see in IT what happened, in 90s they were doing purely staffing service, there was not much of value add, then they started doing ERPs, then web development and now they are taking very complicated projects of USD 3 billion or complete buy outs and all. So, this is how it happens.
In pharma also the 5-6 bigger companies they have the same kind of ambition and finally they will go to even do the research on the new molecules when they have that kind of balance sheet and they will even attack that particular segment which is most juicy and very large. So, I do not have any doubts that top 4-6 competent companies there is very high probability that they will come back, whether it happens in second half of this year or after 1 or 2 years… it is a writing on the wall, it will definitely come back.
Q: In this big 2017 midcap, small cap boom, one of the sectors where seem to have got several fundamentals right is the chemicals industry – Graphite, Speciality Chemicals, is that where you will hunt for value?
Desai: You put it in industrials / domestic materials. Stuff that is domestic oriented, is capex oriented, industrial oriented, I think there is a lot of value. The mid and small caps are trading at 0.5-0.6 times book, they have been crushed. For sure the earnings are depressed and when the earnings come back I think these stocks will get rerated. So, that is certainly a space I would be very bullish on.
Prakash: There is also a clear play that there is a fundamental change in China’s approach to pollution vis-à-vis chemicals. So, the reason why there is a paradigm shift there is that China has adopted the blue skies policy under which there has been a significant attempt to reduce pollution. The entire industrial zones have been shut down which were heavily chemical oriented. So, many multinational companies are no longer comfortable with only having a single source coming out of China because the predictability has reduced as well as prices have gone up dramatically. If you look at rest of Asia the only other country with any chemical complex beyond China is India. So, this is I think a genuine long term secular opportunity to gain market share for Indian chemical companies which is very much linked to China raising prices and becoming less reliable as a supplier.
Q: You want to extend that argument to paper as well? There is plastic ban in India and we have seen some of the earnings play out. So, something similar you think can happen with paper stocks as well?
Desai: I think it resonates with the point that Akash made. Capacities around the world are shrinking, there aren’t that many manufacturing locations that can offer the competitiveness that east of the world does and China is defocusing on all these things. So, there is an opportunity set for India. Actually there is a broader theme around this which comes out of the trade war between US and China but India has to be very quick to capitalise on this. We can actually get a lot of manufacturing and finally the Make in India thing can happen as a consequence of companies requiring or needing to diversify their manufacturing locations and India is a pretty viable place to do it.
For the first time I am sensing that boards outside India are not so frightened about green field in India. They had been forever frightened. They have not hesitated in acquiring, that has been okay for them – take an existing business and run it. However setting it up from scratch is something that they have been hesitant about. I think now is the time when I see that there will be companies that will walk in and say let us setup capacity from scratch.
Q: That is ease of doing business for you?
Desai: May be.
Q: We have not discussed the interest rate theme and taking it along with the debt market problem that is currently underway, will it make the cost of capital so expensive? Who are the winners and losers of this trade?
Agrawal: Clearly the growth of larger NBFCs which came under stress, they themselves must have realised that if liability franchise is not with them and they are dependent on banks or mutual funds, I think that is not a very reliable, I mean you cannot have ALM mismatch in that kind of situation.
For the first time I am understanding that banks are really precious who have the best liability franchise. Even if their asset book is not doing very well but if they have a fantastic liability franchise which is reliable and long term and growing, I think that is a huge source of value creation right now.
Q: Do you see a high interest rate scenario and there are people who expect that the food disinflation was very severe and it is over. Sugar prices already globally have gone up and crude could add to it if it worked the way Morgan Stanley is predicting. So, is there a rate hike scenario and therefore do you have to think of different kind of discounting? What is your general interest rate scenario you are looking at for 2019?
Agrawal: Monetary Policy Committee (MPC) last 2-3 years it has been there, we are more or less sure that interest rate will not go beyond 5 percent or 5.5 percent. However inflationary expectation in the minds of the people have not come down to 5 percent. So, that is the gap. In fact that is one of the biggest opportunity because your inflation remains at 5 percent, you take the rupee from 64 to 72, so that devaluation of rupee or making your exports competitive is real because your cost side inflation is only 5 percent whereas devaluation is at 10-12 percent. So, this time by sense is with a gap it will respond – the export surge and the US China trade war, that will also open up opportunities.
Q: The biggest bet for next Samvat?
Agrawal: The biggest opportunity in India is to remain invested. I have seen in 40 years this index going from 100 to 34000. So, that same opportunity or even bigger opportunity is there in next 10-30 years. So, all the young people must buy.
Q: What is the stock or sector of Samvat 2075?
Agrawal: Auto would be one of the good segments to look at. Even the private financials, particularly mid-size banks which is doing very well, which has a management in place and liability franchise it just about to be built. There are lot of banks in India which are work in progress. So, wherever this magic is happening where they are reaching the critical size and they have got the brand equity to attract liability, those are the banks which are going to do very well.
Q: Your top bet?
Desai: I would say mid-sized corporate banks.
Prakash: I think private sector corporate banks.
Desai: I think the loan cycle is turning, the competition of NBFCs has receded, mid-sized corporate banks actually half decent liability franchises, rates are little bit higher which is good for them because their margins actually perk up a bit, they will gain share, NPL cycle is behind us and valuations – most of them are sub 1 times book, you are not paying book value for any of them.
Q: There should not be any issue of promoter holding?
Desai: Mid-sized corporate banks this issue is not there. These are banks that have been around for really long time and they have managed their businesses pretty well. They have been at the wrong end of the cycle.
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