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GST is being used as an alibi for consolidation: Hiren Ved, Alchemy Capital

Aggregate earnings recovery could be round the corner -- two or three quarters down the line.

ET Now|
Last Updated: Jul 03, 2017, 03.50 PM IST|Original: Jul 03, 2017, 03.34 PM IST

In a chat with ET Now, Hiren Ved, Alchemy Capital, says markets have already run up in anticipation of strong earnings.

Edited excerpts:

There has been a lot of apprehensions about the GST impact, at least in the short term. There are enough brokerage notes which have come out which are making a case that auto, FMCG and pharma companies will struggle and there will be an earnings drop of if not two quarters at least one quarter?

We do not know exactly. It is fair to say that there might be some short-term disruptions that might happen but my interaction with some of the larger companies is that they saw this coming, unlike demonetisation which arrived unannounced. GST is something that we have been talking about for long. One lesson from demonetisation was that India is an extremely adaptable country.

People adapt to change and we are also fairly tolerant. Destocking and restocking is something that the markets typically tend to look at in the future. GST is now almost the present, it is not the future and unless that gets reflected into some form of earnings which we will only come to know when the quarterly results come, I do not think the markets are going to be too bothered about what is going to happen on GST.

In the near term, for a market which has been running on liquidity and hope, GST implementation will come at a cost. It will have an impact on FMCG, pharma and auto companies. It may be a quarterly aberration but will it push back your earnings recovery by three months, six months?

Possibly. That could happen selectively. We have been talking about an earnings recovery for a long time now but possibly the market is sensing an earnings recovery sometime in the second half of this year. Liquidity is always going to be important because without money, you cannot buy stocks.

Given the way interest rates are in the economy, given the way inflation is, we are just seeing the beginning of money flowing into equity markets from domestic savings. The market is just taking a pause before a big rise. GST is being used as an alibi for consolidation and finally the markets will discount the future.

It takes about two-three years after a crisis to set things right. Things started to go downhill in India in 2011, culminated into a crisis in 2013. It has taken us two and half, three years to get out of that from a macro standpoint and it has never happened that-- in fact, in the initial phase when you try to correct the macro you take a hit on broad corporate earnings and that has what has happened in India.

In the last 24-36 months, we have probably seen Nifty earnings flattish to 2% compounding. Somewhere that is in the base now and with a good monsoon, commodity including oil prices down, inflation down, we should be seeing a recovery in earnings around the corner.

Whether it is delayed by a quarter or two because of GST, we will figure that out but even if you plot the quarterly earnings between 1991 and 1994, it is quite interesting that you will see in 1991 we had a crisis and then Manmohan Singh and Narsimha Rao were there and they took various steps to turn things around. If you plot the earnings growth during that time, it was almost flattish to negative and then in September 1994, the quarterly earnings spiked but the markets started to rally from September 1993, a full one year ahead of earnings growing.

We may be seeing something very similar. From 2013 onwards, we have been solving the macro crisis. It has taken us two and a half, three years. Earnings have been flat and now markets are rising and people are complaining that probably valuations look expensive but markets typically tend to discount the future.

The market is pricing in the spurt in earnings that will come in FY19?

Yes, absolutely or may be in the second half.

FY19 largely before the GST comes in then, right?

Exactly. It could be the last quarter of this year, it could be the second half of this year and then well into the next year.

Markets have already run up in anticipation of strong earnings. Let us work with the assumption that earnings recovery happens in the second half of this year or first half of FY19. When earnings recovery happens, everyone would say look stock prices have already run up, we knew this was about to happen…

But that always happens in the sense that because the market anticipates a recovery, when the recovery actually happens, the markets might go into a correction and consolidation mode and we have to understand that at turning points, earnings is always a lagging indicator, the PE goes up first and earnings follow later.

Similarly, on the way down, if in mid 2008 if you asked Indian corporates they would say I do not know what is the problem, the problem is in the US, my earnings are doing fine. But the market was sensing a problem and the PE collapsed first and the earnings collapsed later on.

We are seeing the reverse of that cycle happening now. Now I am sure that there are certain areas or pockets in the market which are expensive. There is no doubt about it but when we talk about markets we talk of aggregate earnings and aggregate earnings recovery could be round the corner whether it is two quarters down the line or three quarters down the line we will figure that out but my sense is that markets are sensing a recovery.

Are you fully invested in this market?

No, we still have some cash?

Why is that? If you are so confident of earnings’ recovery, then you should be fully invested?

We are deploying cash as we go along. We do not look at a broad market call and invest. We find individual opportunities and we tend to keep investing in the markets.

Where are you finding those opportunities right now because that is the constant stress point because valuations even for the mid-caps and small caps have gone ahead?

The the way I would look at opportunities is if you put in four buckets; bucket one is where there is great visibility. Everybody knows that these companies are growing and that is where the market has rerated those companies. You cannot expect any PE rerating there.

For example, a Bajaj Finance.

Yes. These companies are now doing well. The market recognises that and you could still earn equivalent of earnings growth but you cannot expect any PE or price to book multiple expansion there. Then there is the second bucket where the balance sheet is good but the P&L was not doing anything for the last few years. So either because of company specific issues or because there was headwinds in the industry, for whatever reason but these were companies which did not have a leveraged balance sheet, the balance sheet was fine but there was no revenue momentum. That is where the opportunity is today. It could be across several sectors.

The third is the most leveraged companies where the P&L and balance sheet both were bad and now we are seeing a deleveraging cycle. But there again, which ones will survive and which ones will thrive we do not know. Our sense is that it is better to play seen rather than blind in that bucket and it is also the most risky bucket so to speak.

The fourth is where you look at new opportunities when new IPOs come if there are interesting companies. Essentially, today the idea is how do you create a portfolio between these four buckets. The first one is very simple, they are your compounders, they are well discovered stories, the second one where you have to really do some hard work and that is where you find opportunities like for example, our sense is that for example, once GST rolls out I think you will see progressively, not immediately but progressively, that SME balance sheets will be more credible because now everybody has to pay taxes.

If you are in business you will pay taxes and today banks will be most happy to lend to an SME balance sheet which is more credible than what it was in the past. And today there were banks or NBFC which were specialising in lending to SMEs but it was always considered to be an area which was high risk compared to lending to a consumer for example or whatever and I think everybody gravitated towards retail lending because that was so easy, you know mortgages so and so forth but today SME could be a big opportunity.


How does one participate if you are bullish on SME business?

Look at banks which have large exposure to SME. Look at private banks which have exposure to SME, look at NBFC which were…regional banks, regional private banks, NBFCs which are focussed on SME lending. That could be a big area of opportunity to open up over the next few years.

On a public forum recently, you have made a presentation that you like Varun Beverages it is in public domain now. Varun Beverages falls in which bucket?

Varun Beverages falls to some extent in the second bucket because the capex phase is done and we are now going to see the benefit of growth. We are also likely to see significant savings from logistics cost because it is a very freight intensive industry and as they get contiguous regions to sell, the asset utilisation will improve from here onwards.

The third thing that I mentioned there was that once this government is focussing on power 24x7 to be rolled out and if power is available, then you can sell soft drinks and water and juices because if you had only two to three hours of power and did not have refrigeration, how could you sell beverages? There are multiple levers for growth there, there is relative under penetration in that market. But again this is my disclaimer that we do have an exposure to that company and you guys should do your own research.

What do you own from the bucket one, which is the easy bucket which is a open bucket right?

We own auto companies, we own Maruti, we own Bajaj Finance, we own HDFC Bank, we own the good quality companies.

That is how much of your portfolio?

That should be 35%-40% of the portfolio.

We are talking about ITC today where would you and how would you look at it?

We own that as well. We bought that a couple of months ago.

I would reckon that would also be bordering between case one and case two, right?

What has happened is that in the last few years, these companies faced a lot of headwinds in terms of incremental taxes and now with GST coming in and a cap on cess, a lot of the bad news is in the price. ITC also witnessed almost negative volume growth for a long period of time. And when you aggressively raise taxes and you have to raise prices, it impacts demand but what happens after a point in time is that the consumer gets used to a new price point. Compared to other FMCGs for example ITC underperformed for quite some time. Those are what I would call as companies in the second bucket where something either specific to the company or because it was external to the company, there were a lot of headwinds.

The same thing has happened in liquor. There were so many bands in several states. Then the Supreme Court verdict came in banning shops from selling liquor about 500 metres from the highway. They have been taking it on the chin but these companies have been doing good work internally. They have been cutting costs, they have been trying to scrunch working capital and capital employed in the business.

At some point in time volume growth will happen and that will be in the price so typically when the crisis hits the most is when you get the these kind of stocks at a very good price so my sense is that they are all in a bottom formation and hopefully over the next few years these companies will do well.

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