Neelkanth Mishra is managing director and India Equity Strategist, Credit Suisse. He has been rated among the best analysts in India by the Institutional Investor and Asia Money polls. He has been an advisor to committees appointed by the government such as the RNR committee on GST and the FRBM Review committee. Mishra also covers Metals and Mining, and has earlier worked on Indian Pharmaceuticals.
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Mishra said the relative underperformance of private corporate banks is staggering and the banks are getting enormous pricing power now because the non-banking financial companies (NBFCs) have disappeared from the space.
In an exclusive interview to CNBC-TV18, Mishra said he is worried about the lack of growth in NBFCs space as balance sheets of several firms in this sector are smaller than they were in September.
In a wide-ranging interview, Mishra also discussed the power sector and its future, NBFC sector, among a variety of topics.
Watch the video here:
I was going through your note where you say that the gross fixed capital formation numbers which is the broadest measure of investments have revealed some surprises specifically with respect to private capital expenditure (capex). Can you take us through what the gist of your report is and why you are so bullish on some of these themes?
As you said, the gross fixed capital formation which is the broadest measure and that is what everyone tracks and there was a very sharp decline in the gross fixed capital formation (GFCF) to gross domestic product (GDP) ratio. This is the broadest measure of investment that you can see.
In our market, everyone is looking at investment stocks, investment revenues and it so happened that it coincided with a decline in industrial earnings and price to earnings as well. So we investigated this and given that in the last six instances GFCF to GDP ratio has been climbing steadily.
The question was can they sustain. We found that if you drill down into GFCF most of the slowdown has come from the informal sector. In fact, private corporate capex has been growing in the mid-teens, actually 14 percent CAGR. Of course, the machinery capex was up only about 10 percent and it is much larger than what we had expected.
Intellectual property investment has been growing at 22 percent a year. So there is still quite a bit of investment happening. What is surprising to us was that household even in nominal terms, there was effectively no change. The third big surprise was that contrary to the consensus view that the government has been responsible for pick up in capex. Actually, the government sector has been investing at the same pace for most of the last 7-8 years.
So the GFCF to GDP from the government or the public sector has actually been flat. Second, the fact that the GFCF from the government or the public sector has been keeping pace with GDP means that it’s much more sustainable. It is not that they are suddenly going to dry up as the government sector competes with each other on fiscal profligacy which makes this much more sustainable and last.
On the private sector, we took a list of 12,000 companies and looked at their capex and what was quite surprising was that the slowdown seems to be in two segments; metals and power. Now we think that steel capex has started, our view remains that power capex also, in two-three years, will start off. So I think that this is setting the ground for a very meaningful and sustainable recovery investment activity.
What is the percentage, a composition of the informal sector, private capex and government in gross fixed capital formation basket?
Private sector contributes 43 percent, 25 percent is public sector and 32 percent is household. To give you the numbers as well – of that 25 percent in public sector, about 2/3rd comes from state government and Central Public Sector Enterprises (CPSE) and a very small percentage is actually the central budgetary allocation.
For the private sector, all of this is MCA21 data, so this is as solid as you get. The household is actually the residual.
Coming back to that one point that you made about the pickup in capex. Earlier when there was a stagnation in capex it also had slowed down a lot of bank loans to the industries, especially power and metals which was at one point half of the sanctions, as you mentioned in your note. Now how do we see that piece of the puzzle evolve?
That activity is also picking up as the margin and the insolvent companies are being taken over. So the more solvent companies are taking loans to take them over and there was also a phase where loans were being written down, so the aggregate exposure to the industry was starting to come off and our sense is that that’s been one part of the loan book of banks which has struggled and stagnated.
If you see the relative performance of the private corporate banks compared to the private retail banks, it’s been staggering and now that bulk of the problems are known, many of them still have to be recognised in balance sheets.
The banks are getting enormous pricing power now because the NBFCs have disappeared from the space, the pricing power is coming back. So there should be net interest margin expansion and on the relative basis they have struggled and lagged the market. So that is another area where we find opportunity.
I am not surprised at all to see L&T for instance. Even their Q2 numbers indicated a fair amount of robustness and the argument on State Bank of India (SBI) and ICICI is being shared across. We saw Morgan Stanley report, the intriguing name is Bharat Heavy Electricals Ltd (BHEL). Nobody has mentioned that name, power sector, yes, nobody is invested in that sector but there are so many going for absolute disastrous valuations, the distribution companies (DISCOMs) problem has not been repaired at all. Why would anyone invest in a new power company and if they don’t, why will BHEL get orders?
I know you have been doing this for a while. One of the critical aspects of choosing a stock is because the company could be doing well but the stock could be overvalued. One of the first instinct is to look at stuff that no one else is looking at and that is not good enough because if you had done that with specific stocks that you mentioned, you would have lost money for many years. But now what we are seeing is that look at India’s energy needs. To grow GDP at 7 percent, you need energy supply to grow at 4.5 percent because your efficiency gains cannot be more than 2.5 percent a year. Anyway, they are the best in the world, this is the note we had written in October and if you have to grow at 4.5, how do you get that energy.
Almost all dense forms of energy are imported. Oil, gas, metallurgical coal, the only thing you have is thermal coal and renewables and renewables are not large enough and people think that it will solve a problem, I hope and pray it does but on current economics, it doesn’t seem to be in a position to meet our energy needs.
If you have to provide energy to people, you have to mine more coal and you have to produce more thermal power.
What has happened in the last year and a half or so is that utilisation has started to pick up, you would say that average utilisation of 62-63 percent is nothing to be excited about but peak utilisations have gone up.
You will be surprised, I was at a village in northeast Bihar about a month back, I was shocked, there was ice cream selling there. What that means that a cold chain is working. I would not have wanted to have that ice cream because perhaps the cold chain may have failed at some point in that supply chain but the fact that it was there was surprising and the retailer is stocking that ice cream means that he has power for the most part of the day. If you have steady power and in that part, we used to expect 7-8 hours of power and now we have 22-23 hours of power. Which means that peak demand, peak utilisations have actually shot up.
So what we are tracking is 62-63 percent utilisation in an average level but the moment you look at peak utilisation, you are already in the 70s and our demand is rising at 6 percent.
So in 3-4 years’ time, you are going to need more capacity and if you are going to need capacity, you need to start setting it up now. I think that realisation is not there in the market and people are worried about receivables for equipment companies and for power generation companies but the business reality is that you need more power.
We did go overweight on utilities at that time, not specific stock names but we do think that ecosystem is unlocked and has reasonably good prospects.
I wanted to talk to you about your caution with respect to non-banking financial companies (NBFCs), you have mentioned it several times in your report about the slowdown etc but that has not echoed by the views that we got from Keki Mistry, VC and CEO of HDFC, said that higher optimism a couple of years back led to increase in number of NBFCs and added that most NBFCs were set up on account of getting better valuations. Mistry also said that confidence will return once again in the industry, in fact, a lot of CPs (commercial papers) are getting paid off as we speak, where does your concern stem from then?
I think if you are running any business, you are not thinking of the next six months or twelve months. When you set up a business and you are running it, you think that companies theoretically are forever and so do private sector. NBFCs have a great future, 10-15 years. Absolutely, they are going through a bad phase in the cycle.
Yes, we are. I don’t expect this to be – let me first say that there is a lot of loosely used phrases like India’s Lehman moment and all that which I think is very irresponsible. It is absolutely nothing like that. Indian NBFCs are very well capitalised, we are talking about assets to equity at 4.5 for the NBFCs and 7.5-8 for the housing finance companies (HFCs), so there is no risk of cascading defaults and the whole system shutting down.
However, at the same time, what is happening is that there is a problem of growth that many of the NBFCs, especially the ones that do not have a known corporate brand name and therefore, cannot rely on access to liquidity even when there is a higher amount of risk aversion. They are slowing down – some of them have shrunk, their balance sheets are smaller now than they were at the end of September. So this is what I am worried about. I am worried about the lack of growth, I am not worried about cascading default, there could be one or two NBFCs where balance sheets are an issue but by and large, it is an issue of growth.
The good thing is the near-term liquidity has eased so, therefore, things have started to move but at the same time, the one-three year market is not eased and that suggests that if you do not want to get into an ALM mismatch problem again then you are not going to be growing too much and that is why we think that this will have a drag. This is very negative for growth.
There are dealers, distributors who relied on loan against property (LAP) to get funding, to get working capital and there is slow down happening. There is a lot of ever-greening stuff, which was starting to happen which slows down, there could be some risks of - so while the NBFCs are now safe, their borrowers are safe.
They are very fragmented sets, I don’t think it will be any massive defaults but at a very fragmented level, you will start seeing problems emerge and till those problems are discovered there will be some uncertainty and NBFC system will grow a lot slower than it was in the last three year.
That is all we are saying, we are not saying that you don’t have a future. You need massive penetration of formal finance in this economy. I think the technology changes and the excellent management teams that exist have a great future but we need to see a lot of correction before we embark on the next upturn.
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