When do you think the revival on the consumption and investment front will happen?
It is very difficult to model an economy saying exactly what will cause it to revive. Just six months back, could we have expected the amount of slowdown in auto sales that we see now? Similarly, it will be very difficult for someone to catch the bottom. But you can look at the drivers of the economy and the direction they are going.
Basically an economy gets stimulus from three levers – fiscal, monetary and exchange rate — and the heavy lifting has to be done by the monetary policy because we have gone in for a fairly disciplined fiscal deficit. I personally think rupee is a bit expensive but whatever that may be, I do not think the dollar is strengthening very strongly globally, in which case you are probably looking at a stable currency right now. You are not likely to get stimulus from there. We have seen the 10-year bond yield come down quite significantly.
We have to wait for it to percolate to the economy where home loans, auto loans users see a drop in their interest rates. The interest rate channel also works through valuation of assets. About 40% to 50% of government securities have appreciated in value and that creates a wealth effect by itself. There are multiple channels the monetary policy works through. Clearly that is what will provide the stimulus for this economy to turn around. But whether it takes two month, three months, six months is going to be very difficult.
A lot of it boils down to world growth. The global trade data is probably as bad as 2016 beginning and starting to go towards 2009 kind of levels because South Korea, Singapore are already in recession.
So to that extent, you also need a bit of luck from the global side. Global equities have done well because interest rates have gone down but clearly the PMIs you see globally, the index of industrial production, the trade data everything is quite negative at this point of time. One is hoping that you hit the bottom in global growth. Any recovery from there, combined with monetary policy playing out in India is what is going to turn the economy around.
Given that private sector capex is poor and it is unlikely to pick up because of x, y, z reasons, where is the economy headed? Consumption is slowing down, investment is yet to pick up. I guess we are getting crunch now!
The point is what drives consumption? A lot of it is softer factors like animal spirits and sentiments and you never know when they come back. If you look at consumption from a very top-down macroeconomic perspective, you take the assets of the household sector versus the debt. India has super balance sheet on the household side. In fact, our estimate is that it is a better balance sheet than there in US because if you take the assets to debt ratio, the household sector balance sheet on an aggregate basis is quite fine.
Clearly from income and the P&L perspective, in the last five, six years, not too many people have seen their salaries, profits go up too much. But as I said, the balance sheet is fine. It is not that consumption is being stalled structurally by a bad balance sheet at the household level. I am not sure you can say that consumption will not pick up because balance sheet is fine. If you see certain segments, especially the premium segments, when you look at luxury cars, air travel, QSR, it is not that nothing is firing. There are segments, even AC sales are quite strong at this point of time.
There are segments which are firing and I do not think it is a problem of affordability or balance sheet. It is just a question of sentiments to a large extent and that is what drives the economy back to recovery. It is a mix of hard factors like interest rates and global growth and all that but it is also a bit of sentiments which are very difficult to predict along with the fact that also what tends to happen in many industries is when the final sales goes down, say 2%, the manufacturer actually sees 10% because the entire inventory channel destocks.
So there is a kind of escalation of that. It is not easy to predict that consumption will not come back. But as generally interest rates are a very powerful tool for the economy, that along with a bit of global growth should drive sentiments back.
Everyone is betting on a rate cut. What is the best case scenario here? What would be the best place to be in the markets? Would you be looking at discretionaries, utilities, banks, what would you say is the best way to go?
I do not think a single rate cut does it. This economy needs maybe 50-100 bps of easing on the 10-year yield and probably much more on the user side. The first 75 bps or so clearly has not really played out either in the corporate which is borrowing or at the consumer who has a home or auto loan. The transmission is probably a matter of time and that should happen.
Effectively, the user is probably looking at 100 bps or 150 bps kind of reduction. If that happens, given the slow economy, the rate sensitives with a value bias is where we are positioned. We are talking about sectors like corporate banks, utilities, real estate, hotels. Those are the spaces that we think are good risk reward at this point of time.
What is your take on individual sectors? How are you positioning yourself within the auto space, given the slowdown that we have witnessed?
Auto is a bit of a tricky sector. What has happened is we are seeing a very sharp cyclical slowdown. There is also an overlay of a long-term disruption in terms of EV. Obviously, it will take a lot of time but it will probably get manifested in the multiples rather than earnings at this point of time.
If you see, globally auto sector multiples are very low at this point because the path to that technology — be it hybrid or a full battery based EV — is not very clear at this point of time and a lot of ancillaries have exposure to different parts which may or may not be required in an EV.
In general, I am more in favour of the CV cycle rather than the PV cycle because the passenger vehicles tend to be less cyclical and more compounding kind of growth versus the CV cycle. PV is where the technology is probably going to be the focus. What is going to happen is you are going to see companies divert their cash flow or do various kinds of alliances to come over this technology hump in a certain sense.
It is very difficult to predict what they are going to have to sacrifice to be able to manage this wave of technology change that is coming and obviously markets do not like uncertainty for a long term and to a certain extent the auto sector, especially the PV side is facing that.
The two-wheeler side also has a disruption potential along with the fact that it is very penetrated and so it is not going to be a high growth sector on a 5-10 year basis. Among all the spaces, the most cyclical sector which is the CV cycle is probably worth a bigger bet than the other segments.
Where are you still convinced that the structural demand/earnings is still intact? The markets may be nervous because of variety of factors but which is a trend in the making? Which are some of those ideas where you are a convinced buyer come rain or sunshine?
It is not easy to find that kind of resilience but basically, the economy is slow. We have to accept the fact that we do not know how long it is going to be slow. It is probably a good strategy to buy into stocks where there is consolidation in the industry and which are getting market share at a valuation you are comfortable with.
Obviously a lot of these names are expensive but in real estate, aviation, hotels, there is consolidation and some of these companies are garnering market share. Even in a slow economy this company or this segment is getting market share and there is a 10-15-20% growth in earnings for the next two years at a reasonable valuation and if they economy picks up then you get a bigger upside.
The other way to play is asset-based cyclicals like cement, midcap cement maybe, where you have a certain operating cash flow or free cash flow yield and you say that if this is roughly equal to my risk free rate, I will just hold it as a quasi debt stock till the cycle comes through. If the cycle comes through, it is a multi bagger. So, you have to match these two themes and build a portfolio. You will always have to have high quality stuff like retail banks which I think are still fine because there is obviously market share gain not only from PSU banks but also from NBFCs at this point of time. So mix and match the portfolio between these three buckets.
Given the condition of market is in and how low prices are, some of the stocks are at all-time highs. So a trend is definitely emerging. How do you explain the dichotomy?
You have to realise that it is a very big market. Even after a slowdown, which we have seen over the last five-six years, the Mumbai market has seen Rs 50,000-60,000 crore in new home sales. The top eight cities are probably a Rs 2 lakh crore odd kind of market. Obviously it is a very big market. The sales are probably the same as 2010 and it has gone through a fairly prolonged consolidation in terms of sales.
Is there a basis to say that this industry is going to consolidate? The jury is quite clear that when you take RERA, GST, demonetisation, NBFC crisis — everything seems to point to the fact that your top five or top seven developers in each city will get a disproportionate market share.
Some of the companies may become very big and which is why the state of the industry is diverging from the state of the stocks. Clearly even if the market is not going to grow for two-three years because real estate prices are going to be flattish, if I can find a company which has a good balance sheet and is aggressive in sales, then if it is available below your NAV assumptions, it is a good bet.
Your overall portfolio includes some of the Tata Group companies such as Indian Hotels, Trent and Tata Global BeveragesNSE 0.78 %. Can you just elaborate a little bit more on the rationale and tell us what kind of companies you are picking?
It is not frankly a group level call we are making, it is company specific. I cannot talk about individual companies but hotels is again one of the sectors where we feel the downside is limited. There is a bit of a consolidation going on and if at all the cycle comes out strongly you make a lot of money.
As I said you want to be in sectors where the downside is protected either by asset or normalised earnings. So, one of the companies is a consumer company where the portfolio is changing to a very exciting configuration because the premium segment is doing well. The premium QSR like a coffee chain has obviously got a lot of potential in this country. There are options of converting some unbranded categories into branded. Each company is actually very different.
Do you think a good well run equity scheme like a Reliance growth scheme can give double digit CAGR returns for next three to four years?
I am very confident of that because apart from the scheme, my overall configuration is from a top down perspective. In last 30 years, the broad way India works was having consumer inflation of 8%, nominal GDP of 14%. Inflation differential with US was 4% to 5% which was exactly the rupee depreciation if you take what happened on 30-year basis and that nominal GDP of 14-15% is broadly the same as what Sensex returns.
The configuration has changed because due to global factors and domestic focus of policy, you are going to see inflation remain at 4-4.5% average, in which case, your nominal GDP goes down to 11-12%, your rupee depreciation probably slows down to 2 to 3% and over the long term, broadly nominal GDP will be very similar to what gets reflected in Nifty or Sensex.
There will be opportunity to create double digit returns purely from the market and then obviously hope that we will create substantial alpha as well. In medium- to long-term, a good fund should create between 13% and 15% return.