Samvat 2076: Manish Chokhani, Raamdeo Agrawal and S Naren on the road ahead for the Indian market: Here is the full transcript

 Naren: It is much clearer for longer-term investors that you invest when the economy is down in cheap stocks and you get very good returns in the long run. We look at five indicators of the economy, one is credit growth, second is power demand, third is oil demand, fourth would be container traffic and fifth would be auto numbers and all these are all high frequency, good quality numbers. All of them are telling you that economy is in bad shape relatively. Therefore, the tough task for us to tell people is that when economy is in bad shape, invest in small caps. When the economy is in great shape, you will be able to make money or you invest in value stocks when the economy is in bad shape and you make money.

The only difference I would say at this point of time while the economy is in bad shape, is many of the large caps or mega caps are not cheap at all. Normally when the economy is in bad shape, you will see the entire market being cheap but this time you can clearly see that the mega caps are not cheap but the rest of the markets are reasonably valued. So if you invest today for the long-term - how long the economy will take to revive, that is a debate, which we don’t have an answer on. My belief is it should take longer but that doesn’t mean this is not a time to invest for the long term.

 Agrawal: Only after sometime we will realise whether that was the worst. I think the kind of pessimism we have gone through – only time will tell because still lot of these six parameters Naren talked about are dogs. We have seen some amount of bottoming out of the pessimism – intense pessimism, which we saw led to government coming back with a lot of steps and they are committed to do even more. They have literally thrown the fiscal to – the RBI is very proactive on the liquidity, cost of money, whatever is possible and then finally the number came that 88 percent decline, the credit flow – I think that is the most scathing statistics you have. So what is happening to that, we will come to know, I don’t think it will go worse than that. The pessimism is at a very low level.

So whenever the market is in very pessimistic mode, of course it will happen with the evidence of some kind of a slowdown, the slowdown is on. Pessimism is on big time, there are more pessimists than optimists despite strong market. For me, it is only a CNBC-TV18 discussion what is to be done, I am 100 percent invested and I will always remain fully invested. Whatever money comes, we have to find one-two ideas and buy into that because we are buying quality and growth (Q&G). Today market is looking high or almost all-time high because the QG stocks are doing very well. So my portfolio is positioned for this particular kind of rally, not that it has done some great numbers but it is at least not showing too much of downside.

 Chokhani: Firstly you should give credit to this claim from corporate data basis.

I think the point he was trying to make is that the top 50 companies as Raamdeo is saying have taken the bulk of the flows away in the market. Also another friend sent me some data recently where he said since the norms came out last year about local mutual funds not being able to do style drift between large caps being Rs 25,000 crore, midcaps being Rs 8,000 crore and then the smaller ones being Rs 3,000 crore. If something falls from Rs 25,000 crore to Rs 22,000 crore, the fund is forced to in a way sell it rather than adding to its position. And that may have kind of accentuated the pain.

So you put these two things together, the carnage which has happened in the broader market is unprecedented, which is why Raamdeo is rightly saying the mood is so pessimistic amongst investors.

I am guessing a lot of professionals picked up early that what was happening was that in this whole churn being caused by goods and services tax (GST) and the move towards the more compliant society, it was the winners and the leaders in every sector who are the more compliant ones who are winning market share and therefore, everyone’s portfolios have tilted towards those people and it includes sectors which normally people would have not touched,

For instance, last year – I don’t know if you are going to show the data – even in real estate, Godrej or Prestige and others did incredibly well. So it has not only been in the financials or only in the consumers, even sectors like the leaders have done disproportionately well and that is the underlying message that you cannot have the entire country getting decimated. If indeed the revival has to come, at some point the trade will move away from quality because again like Raamdeo and I have often expressed, the markets discount what is the rate of change, so you may go from terrible to bad and that may give you a rate of change which is not necessarily the best portfolio to hold long term but there is a trade over there.

 Naren: The problem is not in stock market, if you ask me. People are buying stocks. The problem is that today we have AA companies and companies which we think are AA; they are raising money at high rates. I believe that the problem is that people are not willing to take risk in debt and in my opinion that is the whole problem rather than the problem in equity markets because what is happening is all the companies which require debt, which are decent and not junk, they are not able to get money in debt and that has become a problem and the borrowing cost for them have gone up because somewhere people want to lend only to save companies or they are happy keeping the money idle in debt because that is the challenge, if you ask me. Therefore, there is need to be requirement for people to take risk in debt.

The second is that there is a phenomenal amount of money which is stuck in real estate, in under-construction projects as well as projects where a lot of real estate, even completed, is stuck and somehow people are not willing to drop the price there and selloff and that has become a problem because at the end of the day if you have misallocated money that is a big challenge from India point of view and the biggest challenge the government is dealing with is if individuals or corporate misallocate money, how do you solve it and that is a very complicated debate which the government is going through at this point of time and the day they are able to solve that problem, I think we will be through.

So I would say you need the misallocation to slowly come down in real estate, you need people to take a little bit more risk in debt and you need some animal spirit among the businessmen and the tax concession for new units that was announced is a very good step and I believe we need a much weaker rupee so that exports are incentivised and with these steps we will be through with the problem and I believe that overnight these problems are not going to get resolved. Time will be the biggest healer and slowly the economy will recover is my view at this point of time, but we are clearly towards the bottom and therefore, it’s an interesting period for long-term investors.

 Naren: Over the last 6 months we have been saying that essentially you bet on companies and sectors which have delivered no returns for 12 years; power, telecom, some of the infra spaces and corporate banks. Increasingly if you look at from 2017 top, even many of the smallcaps rather than some quality smallcaps have hardly delivered returns. So I believe that you have a wide variety of stocks and sectors which have delivered no returns for 12 years which are looking appetisingly interesting because if you have not delivered returns for 12 years, no one enters a sector and therefore, incremental competition from new entrants comes down to zero and many of the existing entrants also wind up and go away. So I believe you can pick up anything which has not done well for 12 years, the sectors and I think the next 5-10 years will be very good.

It is very interesting; in 2007 quality like pharma and tech were very cheap and at that point of time people used to say that you cannot bet on quality; you have to bet on infra. Now we are reversed; people say you bet on quality megacaps and do not bother about anything else, but when you have stocks trading at 70-80 PE and marketcap which is running into billions of dollars, I believe that there is very little value whereas there is a huge value in all the sectors which have done badly for 12 years. So that’s how we are looking at it and there is a wide number of stocks.

Agrawal: When Naren spoke it was fantastic to hear but my way of picking stocks --- in a stock market there are multiple ways of making money. Naren makes money in one way by being contrarian.

Agrawal: I can appreciate and get excited about what he is saying and clearly, there is wisdom in that, but our style is not that. Our strategy is QGLP; we will buy quality, growth, longevity and reasonable price (QGLP). So that stays and maybe we will make some less money. Our style is slightly in favour and right now a lot in favour. So obviously you have to pay a price but underlying index is broadly QGLP; I have gone through entire 50 companies except for 3-4 junk everything is --- you get scared when you see what you are competing against.

Indian index is extremely active, it is not passive. It is very active and made up of diversified leader companies, in fact some of the companies which Naren is talking is also there in that. So all the leaders are there of all the businesses and all of them are profit making and dividend paying an against that to compete and beat them, you require a very conscious strategy or the portfolio and we have decided to stick to our QGLP process that is what we have done research on and that is what we understand and that’s what we are comfortable with. So only time will tell. Quality works in good time as well as bad time. Many of the strategies work only in good time. So we are waiting for good time to come for many of the strategies to work. So with the public money particularly I would rather stick with something which works all the time, all-weather stocks.

Agrawal: No, there is no comment on that. He is buying the performance to be coming up.

Agrawal: It will be a blast like all the PSUs; HPCL, BPCL, Coal India – all of them, they are dead for 12 years and dead means literally death has been put this time; 5-6 PE multiple, 7-8-10 percent dividend yield and now on top of it the government is actually saying that we want to sell. People are so apprehensive about this whole process.

Chokhani: Let me preface it by saying how an economic cycle starts. You follow those typical six phases of any emerging market or an economy where in phase one there is a small profit opportunity and everyone is sceptical and if you think back to when you were referring to the Vajpayee government of 2002-03, they started that whole cycle with divestment and privatisation and one company went to Tata, one went to Reliance, one went to Anil Agarwal and one went to Suzuki which were foreigners. They kind of spread the animal spirit there and there was a catalyst which came from the world where commodity prices started taking off, steel for example started doing incredibly well – that’s phase one but it met with scepticism because people say this won’t last government, commodities and so on then that profit spreads because there are contractors or beneficiaries of that start seeing and then you see widespread earnings growth and then the midcaps, smallcaps at the end of the market starts coming in and then the foreign brokers and all will come out with new themes that this time is different, ‘BRICS’ (Brazil, Russia, India, China and South Africa) will be the new world engine and so on and you form an incredible high where we get the price to infinity kind of stocks coming to market with IPOs and so on which we saw with power and real estate in 2008 and then you get that sharp selloff where some market leader or someone gets in trouble, it is unexpected then people who left out they try and buy back but the market starts narrowing and it becomes more and more quality and then interest rates and inflation are peaking so the RBI starts getting after your case and then there is a burst and you come to a situation like we are today where the government, the RBI, investors, bankers, the whole world is jumping at the problem.

Money is available, nobody wants; no one wants to lend, no one wants to borrow. It is what we call phase zero and the catalyst typically starts with new profit opportunity which is so easy that you are kind of incredulous that how can it be so easy and in that way I am happy that finally the government has come back to number one where you have to start fixing the balance sheets and corporate profitability of India. You have busted the balance sheets over the last 7-8 year purge coming from the RBI, government, GST, demonetisation whatever which are all good structural moves and it has taken a flight to quality but reality is the corporate sector profits have gone from 7-8 percent of GDP to 3 percent whereas in the US it has gone closer to 10 percent.

So unless we fix that profit cycle the tax cuts are a good start, divestment and privatisation will be a necessary second step. The third step will be to find 2-3 sectors which the government starts backing that we want to create a profit over here. Illustratively I will give an example, textile industry for instance in India is a very large employer, we have 3 percent global market share at a time when our currency has collapsed, we were 6 to the yuan, in 2008, we are probably close to 11. With that level of depreciation, our exports haven’t gone up, I don’t know what people want that will the rupee go to 100 and miraculously exports will go up I don’t know. Bangladesh and Vietnam market share in textile is double that of India, they are 6 percent. Turkey is equal to India and we have everything growing and then tourism; if you want to create employment you want to create profit opportunity the government has to choose what sectors it wants to go after and create that. So I am glad privatisation has come and having said that BPCL, I think last year ran-up what 80 percent in anticipation of this. It is up Diwali to Diwali 80 percent and he (Raamdeo Agrawal) was tipping at last Diwali, so there is lot more room. Most PSUs are down between 65-80 percent, the aggregate market cap of PSUs is barely Rs 10 lakh crore and if you say disinvestment is Rs 1 lakh every year and assuming the government would not sell more than 51 percent, pretty much in 2-3 years we are out of disinvestment target.

So privatisation is inevitable, we have to do it and once this starts coming in I would not be surprised if these valuations themselves become 2x or 3x because they haven’t indeed fallen from those highs and that is directionally what is giving you hope that these will start being seen as quality like even BPCL figures in his (Raamdeo Agrawal) portfolio. It is quality, just because it is PSU doesn’t mean you write it off and there are enough examples like that.

Naren: I think you have to deleverage the economy, particularly you can’t have, in let’s say Central Mumbai $1-5 million flats just being half constructed or fully constructed without occupants. I believe that something has to be done to resolve capital allocation mistakes and bankruptcy code is something which is a superb step in that regard and we would want to see more closures of all the old problems through the bankruptcy code quickly along with the real estate deleveraging that needs to happen in Central Mumbai and Delhi and Noida and Gurugram. I think if these two happen, that itself pushes the economy from whatever growth we have now by 1-1.5 percent and then after that we have to decide which are the areas where we need to take leadership like the government seems to be taking some steps in electric vehicles for example, I think there is massive opportunity in healthcare services at this point of time given that the world is becoming much older and requires healthcare services at a cheap cost. Like what we did in IT services there is potential in healthcare services.

So I believe that we have to identify 3-4 areas. I think Manish very well spoke about areas like textile, leather and aquaculture -- all the areas where there is some amount of employment possibility along with exports. I think those are all superb areas as well and agriculture as well.

I think in all this, the conclusion is India cannot manage without some amount of rupee depreciation. Rupee touch 68/USD in 2013 and it hovers at 71-72/USD six years later, I think while Manish correctly pointed out, there is need for rupee deprecation against dollar because the inflation differential is still there and I think without rupee becoming cheaper it is very difficult to push exports and export has to improve in India and that has always been the way most of the corporates have done. I am not saying it can be done like China but at least we need to have a better export sector than we have today.

Agrawal: Let me put why we are in finance sector. 25-30 percent of our portfolio even today is still in finance sector. Why?

Agrawal: Yes, of course. Led by that. One of the things is that credit intensity in the economy which is about 70 percent of the gross domestic product (GDP) – so Rs 200 lakh crore of our GDP, the outstanding credit must be about Rs 140-150 lakh crore. But world over what happens is the next $3 trillion will have a significantly higher credit intensity. So if the credit flow is not there, there is no GDP.

You can make it minus 100 percent and there is no GDP growth. That kind of thing. It is just one-to-one correlation. So it is a tower of credit. So my sense is that we will go to $3 trillion, we wrote about this trillion dollar economy in 2008. So we are watching it for the last ten years, it will go to $6 trillion and it will go to $12 trillion also, but let us talk about this $6 trillion and this will happen by 2026-2027.

When this happens, you will need about Rs 200-250 lakh crore of credit to be underwritten in next six-seven years.

Agrawal: And secondly, which are the institutions. public sector undertaking (PSU) banks – what performance has been and I don’t see it significantly improving whatever they do, consolidation and all. Second, non-banking financial companies (NBFCs) which was the real discovery of last ten years, they have started delivering last mile and everything, even that has gone haywire. So at least it will take some time to come back again. So my sense is all this credit delivery institutions, four-six banks, whatever is there, they are going to have - it is a lenders’ market where you will have liability cost on their side, lending price will be there, operating cost will be low because digital and other things are happening, cost to income is continuously falling. So we won’t be surprised in five years’ time if you have the highest net interest margins (NIMs) for this institution -- not 4.3-4.4 but closer to 4.7-4.8 unless something dramatically changes.

Chokhani: I completely support that and as the economy will get more and more financialised and I recall last year even we spoke about private banks, we spoke about asset management companies, which have done incredibly well, we spoke about life insurance, which has also done very well. Thematically it is a no-brainer to be in this space.

Like he rightly said, it is kind of becoming a winner take all because the weaker ones or the less capable managements or the less compliant managements are all falling by the wayside. It seems strange to me that a $3 trillion country will not have a $100 billion bank. HDFC is not yet a $100 billion and surely that will be the largest marketcap bank – it is already – it will be the largest marketcap company of India going ahead.

Each time someone says, this is the next HDFC Bank, we both quietly just go and buy some more of HDFC Bank because there is no use reinventing the wheel when there is such a long runway ahead of you. Similarly for asset management companies, life insurance and so on.

Naren: I think pharmaceuticals and power would be two sectors, which we like both for the medium-term and long-term. Both have done badly now for quite some time and I don’t see that the amount of money spending on either electricity or healthcare is going down. So clearly for me, both pharmaceutical and power would be my top sectors.

Agrawal: Stocks to nahi bolenge. I think there is an opportunity selectively in all segments of financials, private financials but the winners whether it is insurance, whether it is private insurance, whether it is LIC, GIC, banks, NBFCs, housing finance companies (HFCs), all the segments will be – but you have to bet on the right ones, consolidation will happen and probably consolidation is for real.

Chokhani. I would agree with that. Financials look still the no-brainer and I will add an element of fun for you. I think you cannot have 50 percent of India’s media sector with 50 percent of eyeballs in aggregate available at $6-7 billion. So I leave that thought with you.