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In every sector, 1-2 giants emerging at the cost of the rest: Saurabh Mukherjea

ET Now|
Updated: Dec 03, 2019, 01.34 PM IST
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  • If govt keeps its foot on the reform pedal, expect economic recovery next year.
  • MPC will be cutting rates again. I hope they cut by 25 bps rather than 15 bps.
  • It makes sense to play the best auto OEMs befor the numbers kick in.
It is a very new phase of capitalism in our country where one or two people take away the riches from the sector and the rest of the people are left holding very little, says Saurabh Mukherjea, Founder & CIO, Marcellus Investment. Excerpts from an interview with ETNOW.

The Monetary Policy Committee (MPC) meet kicks off today. With GDP at a six-year low, is it a given that RBI would be cutting rates sixth time in a row?
They will be cutting rates. I hope they cut by 25 bps rather than 15 bps. But given the fiscal situation and how high government borrowing has become, we should also recognise that rate transmission is going to be muted. But it will be astonishing if given the economic weakness all around us, the MPC does not cut rates.

But if the rate transmission is not going to happen, the RBI can continue cutting rates but that is not really going to reflect in the real economy!
Yes, that is right. So what we need is for the government to continue pushing reforms from Delhi. I remain very hopeful of land and labour reforms. It was extremely encouraging to see the beginnings of labour reform process last week. The government proposed and tabled in parliament last week a bill which allows companies to employee people for fixed terms and if this labour reform process continues through the winter and is accompanied by land reforms in the budget session of parliament, that is as good a tonic as we can get, after the 15% tax rate.

The budget should contain middle class tax cuts. Once you have cut corporate tax rates, a cut in middle class taxes would also make sense. A combination of tax cuts, land reforms, labour reforms should help. It is difficult to see what more the government can do on the reforms front. If we can get that, it will be far more tangible as a kicker to the economy than RBI rate cuts.

Are you expecting the government to tweak the income tax slabs and provide any stimulus?
From fiscal arithmetic and economic stimulus perspectives, it makes sense to give people lower down the income spectrum greater tax relief. Whether you do that by cutting the tax rates or by increasing the slabs is a matter of detail that the government will be on top of. But I think giving people at the 5 lakh, 10 lakh, 15 lakh income levels greater tax relief is a far more potent economic stimulus than trying to give the richer people tax breaks.

So my recurring theme is there will be tax breaks for the middle class, lower middle class coming through in the budget. The only question is the extent and how much of a fiscal hit the government is willing to take. Whether that would be accompanied by GST cuts is a big question. I do not have answers to that. There is talk that there might be rationalisation of GST. I hope it is done because the GST structure is a little too complicated out there.

If we can rationalise GST, bring down direct taxes for individuals alongside the already announced corporate tax rates, that will probably be the biggest scale back in Indian taxes for a long time but that obviously will have fiscal costs. This is where we go back to privatisation. If the BPCL privatisation goes through even in the next six months, that will be the biggest privatisation in nearly 20 years. There is lots happening for the market to mull even as the economy struggles.

What do you make of fundraising activity of RBL Bank and YES Bank? How circumspect has the market been on who the investor is who is putting in money?
I am not so sure that the fundraising activities are signalling a turn in the cost of capital cycle for our lenders. The last year and a half has been very circumspect on both private banks and NBFCs, especially the private banks with weaker CASA franchises.

I am not sure the market is yet signalling great deal of enthusiasm in injecting money into banks whose CASA franchise is weak and whose credit selection has been pretty questionable. Perhaps another six months of economic reforms will see a much healthier fund raising climate for our private sector lenders.

What are you making of the unfolding of news in the telecom space? Do you feel that they will manage to get themselves out of the current mess or is it still looking bearish for the next few years?
In a way, telecom is a classic example of what the rest of our economy and the rest of our stock market is going through.
I am not sure the market is yet signalling great deal of enthusiasm in injecting money into banks whose CASA franchise is weak and whose credit selection has been pretty questionable.

-Saurabh Mukherjea

We are ending up concentrating every sector into the hands of one or two players. Telecom is heading towards a duopoly type situation. Similarly, in the case of private sector banking, there are two very strong banks; in NBFCs, there one or two very strong NBFCs/HFCs. This concentration of economic power into the hands of one or two champions, whilst the rest of the sector is struggling is becoming the defining hallmark of our economy and therefore our stock market.

I used to believe that this was limited to sectors like FMCG -- in paints, cooking oil or biscuits. But it now seems to be spreading towards the broader economy and that means we will end up with one or two massive winners where you can make lots of money and then lots of small companies who fall by the wayside to the detriment of their shareholders and employees. It is a very new phase of capitalism in our country where one or two people take away the riches from the sector and the rest of the people are left holding very little.

An interesting note by JP Morgan is saying take profits in the ongoing resolution trade. They are saying the key challenge for the financial sector is credit growth and earnings as well as ROE visibility. Having said that, they continue to be bullish on the top brass of the financials. Do you believe that time has come to be a little more selective within financials?
For the 11 years I have lived in India, I have always believed it is worthwhile being selective in Indian financials. We have a very few cautious conservative lenders who use their shareholders’ and depositors’ money wisely for better or for worse. We have more cowboys than cautious lenders in our financial services sector. What has happened is because of the tightening of capital markets, the concentration of market share in the hands of the cautious lenders is increasing rapidly. So, it is Bajaj Finance and HDFC on the non-bank lender side and HDFC Bank and Kotak Bank on the private sector bank side.

When capital market conditions are tight, the concentration of lending activity in the hands of a few lenders becomes more pronounced. This has very profound ramifications if you assume that in the next 10 years, credit growth in our country would be 10% as opposed to 13% in the preceding decade. Assume that HDFC Bank’s market share goes from the current 7% to say 10% at decade end, that tells us there is a pretty high degree of probability of HDFC Bank becoming 10 times larger than it is today in 10 years; a lender which will be significantly larger than a bank like JP Morgan, which is the world’s most valuable bank, and which lends significantly more than what JP Morgan does today.

If you take the changes in our country and see the longer picture, it gives you a very clear picture of a few giants who makes lots of money for their employees, for their shareholders, for their stakeholders and then lots of smaller companies who are not able to deal with this far more difficult phase of capitalism we are undergoing in our country.

Do you see some kind of status quo continuing until and unless we hear something from the Budget or do you expect to see signs of a turnaround as early as next year?
The status quo is going to be hard to maintain whichever way we look at it, given how stressed the economy is. I reckon the government will keep its foot firmly on the reform pedal. There is no elections in the next 15-16 months. There is no reason why the government will take its foot off the reform pedal.

If the government keeps its foot on the reform pedal, on land reforms, labour reforms and on tax cuts, I reckon we should see an economic recovery next year because the stock markets are already beginning to discount that.

It is discounting it a little bit indiscriminately in all sorts of weaker companies. Some of the weaker companies were rallying once again with no apparent justification but as the reform process bears out, the stock market will discount a recovery and my reckoning is it will discount the recovery in terms of saying here are the best franchises to play if we see a leaner, meaner, more efficient Indian economy over the next five to 10 years.

Anything new that is catching your eye or that you are observing from a near term perspective?
My view is increasingly getting stronger that it does make sense to play the best auto OEMs in terms of the best ROCEs, cash generation capability, franchise strength ahead of the numbers kicking in. I do not think the auto numbers are yet showing any significant recovery -- whether it is for trucks, cars or motorbikes. I reckon two-wheelers will come back quicker than trucks because of the sheer ticket size.

It makes sense for people to look at the two-wheeler OEMs and choose one where they think the probability of a decisive recovery is greatest. For some of our clients’ portfolios, we have bought some Eicher Motors over the last month or so given the strength of the Royal Enfield franchise. We will be looking for more bargains in the sector looking at the OEMs as well to see amongst the OEMs which have strong, high quality franchises and great relationships with the dealer distributor community. Given their valuations, there is at going to be one or two bargains in the auto OEMs that will come through quite strongly in the next couple of years.

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