It is far better to invest in boring businesses than constantly walking on minefields: Nilesh Shah, Kotak AMC
- We are overweight on corp-focused pvt banks, insurance cos, MFs and MFIs.
- What is looking safe is not cheap any more and cheap is not looking safe.
- Don't invest with fixed 3-year horizon.
We have seen a strong comeback in the market in the last couple of weeks. Is this as good as it gets? Has market done its bit on the upside for this calendar and financial year?
Markets today are discounting the negative news. The GDP growth declined to 5% in the June 2019 quarter and most analysts are expecting below 5% GDP growth in September 2019 quarter. But the market is discounting the future. It is trying to build on growth recovery, based on the corrective steps taken by the government and RBI.
If those steps result in the desired results of growth recovery, then we could see the market going forward. But if there is any disappointment on the growth recovery, then these levels will find it difficult to hold.
Data points which have come out -- the print on inflation yesterday, the core data, what SBI economist said on Monday about GDP plunging below 5% -- would the hopes of a small and a mild recovery be dismissed and challenged? Are we staring at a larger prolonged slowdown purely based on the high frequency data?
In inflation, we have a unique scenario where when headline inflation was low and core inflation was higher. We focussed on core inflation or on the expectation that oil prices will go up and headline inflation will eventually go up. Today, when headline inflation is higher because of unseasonal rains impacting food and vegetable prices and core inflation has come down, we are focussed on headline inflation. Somewhere we need to learn from the US Fed where the Dow Jones is at an all-time high level. Economic expansion is the longest in their history. Unemployment rates are at the bottom level and yet they have already cut interest rates three times and the market is taking them as insurance cut.
In our case, we had a hike in insurance rates, in their case they had cuts. Clearly we need to come together from growth point of view and the second quarter results which have come so far have shown interesting trends. One, in an overall gloomy scenario, companies and building material space have expanded margins. Pipes, fittings, tiles have grown rapidly. In a stagnant export market, tiles companies in last nine years, have increased their export almost 10 times from a volume point of view.
Consumer durables numbers have been quite bumper and in excess of 20% growth. The banks NIMs have expanded in an environment where interest rates are supposed to come down. There has been interesting twists and turns in the growth story. As long as we can bring our act together for pushing growth higher from the current low level, the market will be optimistic about the future.
One gets a little worried looking at the telecom stocks right now. DoT has asked telecom companies to pay up the AGR dues within three months and their dues are not meagre. Bharti has dues worth about Rs 62,188 crore, Vodafone-Idea dues stand at Rs 54,184 crore and there are banks with sizeable exposure to Bharti alone. If the telecom companies were to go belly up, what is going to happen to these banks and the kind of ripple effect it will have thereof?
It is a very delicate situation, where companies which are reeling under the burden of competitive pressure are also being made accountable or being asked to pay for earlier or previous dues. Clearly this is a problem area where we require solution between industry, regulator and the government to create a win-win situation. If the burden is shared partially by government, partially by consumers and partially by the bankers and partially by the telecom operators, then probably the burden can be shared and it would not create a ripple effect on the economy.
Undoubtedly we all need telecom connectivity and at the same time, we also have to ensure that the financial system does not get another shock on the NPA side. It requires delicate solution making by combined efforts of the regulator, government, bankers and the telecom industry.
Where is this problem headed? In hindsight, if we buy telecom stocks, will it be remembered as brave investing or stupid investing?
Only time will tell whether the decision is right or wrong but today as portfolio managers we have remained underweight on telecom stocks and this is primarily driven by our inability to understand developing scenario. Time has taught us that it is far better to invest in boring businesses than to invest in businesses where you are constantly walking on the minefields. I have my full sympathy to telecom companies but as an investor, I need policy stability to build my projections.
Is there any opportunity in the market? In investing, if you pay gold for buying silver, you will not make money. Great businesses are not attractively priced, the problem is that what is attractive is not growing. An investor is stuck between a rock and hard place, value versus valuations?
It is a very valid question. What is looking safe is not cheap anymore and what is looking cheap is not looking safe. Let me just point one hope which the market probably is pricing in well; buying into these quality stocks which are trading at super expensive valuations. Many of these companies are multinational companies and legitimately they are paying pretty high royalty to their parents on the technology or services provided.
Over a period of time, if those products can be Indianised and the royalty rates on the same could come down, then to a great extent, these companies will have far higher profitability than what is priced in today.
In some sense, one needs to evaluate these quality multinational companies not only as PE ratio which is profit after tax, but also adding some of the royalty payments which could taper off over the years. If we make that adjustments then to a great extent from super expensive valuations they may come down to just around slightly expensive valuations.
What would be your outlook on aviation? Would you still be positive given the inherent demand scenario or would you say the current commentary is a little troubling?
By and large, I have grown up reading Warren Buffet. His comment on the aviation sector was that if people had shot down Wright Brothers, so many fund managers would have extended their career. Clearly, globally aviation sector has proven to be value destructive rather than earning returns for the investors. Obviously, there are some shining examples and for a while, in India, we also had some shining examples. By and large, aviation is a cyclical business rather than structural business.
The policy uncertainty which comes due to aviation turbine fuel and other factors which are related to aviation sector, makes it very difficult to figure out how to project longer term cash flows or longer term profitability. Keeping that in mind, we have generally tried to buy aviation sector when it is very, very cheap and sell when it is cheap.
Three years ago, Warren Buffet and Charlie Munger both said that look we have not bought aviation stocks but we have bought aviation stocks and investment right now in the aviation sector are so large that is almost equivalent to buying a small airline company in America. If Buffet can change, I am sure you can also change your view on aviation?
Undoubtedly we have to be rigid in terms of our principle but very flexible in terms of its applications and which is where I mentioned that I will buy aviation stocks when they are very, very cheap and sell when they are cheap rather than buying cheap and hoping that they will become expensive.
Keeping in mind the policy uncertainty which is impacting aviation sector, I doubt if it is going to become a structural growth story. There will be undoubtedly growth, more airports are being added, more passengers are being added but will that growth result into profitable growth for the investors in aviation sector? We need more evidence to prove that.
Ultimately it boils down to what returns investors should expect. For someone who is investing money via the SIP route now, what would be the return in the next 3 years?
If you are looking at a three-year horizon to invest in equity, you might as well not invest in equity. You cannot be going in the cricket match saying that first ball I will hook, second ball I will square cut, third ball I will defend! You do not have that luxury. Who knows? The first ball could be a Yorker and if you are hooking, your wicket will be out. So, please do not come to equity market with a fixed time horizon. There will be volatility in market and depending upon volatility, you will have to adjust your stance. So, please do not come with three-year horizon, fixed term. Please come flexible. May be, it will take five years, may be it will take 18 months, may be it will take seven years, who knows?
Equity market, over a longer period of time -- from a bear market to a bear market or a bull market to a bull market -- will give returns which is linked to nominal GDP growth. Some funds may deliver little outperformance, some may deliver little underperformance. But broadly, the indexes will track nominal GDP growth of the country. We are looking at nominal GDP to grow somewhere upwards in lower single digits. That is the kind of return you should expect but please do not expect it on a fixed time horizon.
Everyone is arguing that inflation is low, nominal GDP is down, so do not expect good returns. Now that inflation is making a comeback and we may be nearing the end of the rate cut cycle, do you think we should increase our return expectations?
The spike in inflation because of food and vegetable prices cannot be taken as a permanent increase in inflation. World over, people look at core inflation away from food and fuel prices. If I raise interest rates, it is not going to stop rains or bring rains. If I raise interest rates, it is not going to impact Saudi oil production which will have an influence on prices. It is not going to impact US sanctions on Iran which will have an impact on oil prices.
Clearly we have to focus on core inflation rather than headline inflation and core inflation today is about 3.5%. Your 10-year government securities at 6.5% that is 300 bps real return for the government. Very rarely you see nominal interest rates of 3% in many countries. In India, we have real interest rate burden of 3%. The data published by RBI talks about the average lending rate for the banking sector. The average lending rate for the banking sector minus the repo rate which itself is at a premium to core inflation is one of the highest in recent times. Now this is the burden which Indian entrepreneur is paying and if we try to focus on headline inflation which is influenced by food prices, vegetable prices, fuel prices, we will be going in the wrong direction.
Are you looking further for opportunities in the broader markets?
Within banking and financial services sector, there are three-four compartments; one is public sector banks. By and large, we have been underweight on public sector banks. Of course, there are one or two exceptions but by and large, we are underweight public sector banks. Our reasons for underweight is essentially one compensation policy where average pay of public sector employee is higher than average pay of a private sector bank. At the top, public sector bank executives are paid peanuts compared to private sector executives. Unless and until this pyramid is corrected, public sector banks will not be able to attract talent as they used to in the past and that could have serious implications for their business.
The second thing is related to administrative flexibility of public sector banks. You get rotated every three years from one department to another. This has its advantages but it has also its disadvantages. One does not build specialisation and private sector bank person in treasury will remain there for a lifetime while in public sector bank, the employee will move from treasury to rural department and vice versa.
Unless and until public sector banks are given compensation and administrative flexibility, I do not think they will create value for shareholders.
Second, we are generally overweight on corporate focussed private sector banks which have diversified their exposure and are not heavily exposed to a particular sector or a company.
Third, is financial services like insurance companies -- life as well as general, mutual funds. We think this is a growing area and are selectively overweight in that sector.
The fourth one is microfinance institutes. Microfinance has done reasonably well, we are overweight over that sector also.
Finally comes NBFCs. This is a sector which is going through a fair amount of turbulence. Over here, we are looking to invest in those NBFCs and we are overweight on those NBFCs where liability franchise is solid. They are able to raise resources from multiple sources where governance issues are beyond doubt. There are fairly established standards of governance and the asset quality and accounting standards are beyond questionable calculations. This is where we are looking to invest in banking and financial services.
From a sectoral point of view, we might be just neutral weight but there are pockets where we are selectively overweight like private sector banks, corporate focussed banks, microfinance institutes, good NBFCs and financial services and we are underweight certain pockets like public sector banks.