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Do you think we are in a spot of bother once again? Just when it appeared that the storm had come and gone at least in late November, early December, midcap stocks have started falling again. Are we in for more chop and churn?
Possibly yes. When it comes to midcaps and smallcaps, we have seen a sharp decline since January 2018, when these had peaked and were trading at a significant premium to largecaps. Now that has reversed and we are trading at a fair bit of discount to largecaps.
On an absolute basis, we can see pockets of value in the midcaps and smallcaps. Also from a market perspective, a lot of leveraged positions in the midcap and smallcap space have been unwound. There could be some choppiness when it comes to midcaps and smallcaps but if foreign investors are going to take a three-year time horizon from an investment perspective, it is time to start nibbling into midcaps and smallcaps.
What should one do in this kind of a market? Every time, when I speak to investors they say have a long-term view, start buying on every decline, start accumulating. The problem with that logic is that three years ago those who waited for long term, have lost money and those who bought on every decline, are not left with any money?
That is very well said. I tend to agree broadly with what you are saying. The fact is that the economy has clearly surprised on the downside. All of us grossly underestimated effect of the IL&FS fallout and the important role NBFCs were playing as a whole in the credit dissemination in the last mile in our ecosystem.
Clearly the last three or four quarters of sharp decline or downside in the economy has emerged from the fact that the credit market is completely frozen. NBFCs have been completely out of the market in terms of their ability to lend and that has impacted credit flow across the trade and across sectors. We have had companies like Lever and Britannia saying that there are credit issues with their trade partners or the dealers and wholesalers. But it seems that the worst is behind us and banks have started lending back to NBFCs. The credit will probably normalise over the next three-four quarters.
"NBFCs have been completely out of the market in terms of their ability to lend and that has impacted credit flow across the trade and across sectors. Companies like HUL and Britannia are saying there are credit issues with their trade partners."
As that happens, the economy should mean revert. Today clearly growth is 2 standard deviation below normal. The economy has to get back to normalised growth which will probably take about four quarters. The impact of the economic slowdown has become much broader and the sectors or stocks which have done well in this slowdown, has become narrower. There are very few limited pockets of stocks which have done well, whereas the broader set of stocks have not delivered the kind of returns. All investors can invest into decent quality business to just stay invested and have faith in the long term outlook for the Indian economy.
Have you ever wondered why SBI is not getting fully priced in for the franchise value they have? It is the biggest in credit card, biggest bank, biggest balance sheet, most number of branches, biggest in terms of life insurance. Even the NPAs are the biggest in the industry but their market cap is not the highest in the banking sector?
It is a very interesting case study we had done some time back. SBI is a proxy play on India’s macro economy because they represent 23% of India’s banking. If the economy goes through a downturn or a deep distress, which is what we have been witnessing at this point of time and over the last few years, then all of the pain of the real economy lies on the balance sheet of banks.
SBI being a dominant player cannot escape it. SBI, as a stock, has not delivered any returns to the shareholders for last 10 years. In the eight years before that, SBI has been one of the best performing stocks in the Indian markets and did a 34% CAGR over 8% and the stock actually went 10x.
We are at the bottom of the economy cycle. Though the peak of NPAs is behind SBI. obviously that has taken a significant toll on their profits. We expect that from next year onwards, their profitability will return to more normal levels. There is a significant in the franchise. A disclosure; we own the stock across our portfolios.
Next five years, except for
We are positive on NBFCs as a whole. We were negative on the space two years back because of lot of concerns around the developer exposure for some of these large housing finance companies (HFCs) and the kind of competitive intensity that was there in the sector. My view is that the worst is behind us. The men have been separated from boys.
The sector plays a very important role in dissemination of credit in India and probably shadow banks as they are called globally have a very important role to play in any ecosystem, even in the developed markets. Some of these catastrophes or consolidation that we have seen in the NBFC sector, happen in every cycle.
In 2008, we had few NBFCs that had gone through deep troubles. Cholamandalam Finance used to be Chola DBS at that point of time, a JV between Cholamandalam and DBS and they had a really tough time with very high NPAs and they had to recapitalise Chola and rebuild the whole business again. But NBFCs will do well and if you can buy into or one can invest into high quality, good quality businesses which can be run efficiently and keep credit costs under check, then there is money to be made in the sector.
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