‘We will See a Period of Strong Earnings Growth’
banks are not comparable to the best in the private sector but they are sustainable businesses nevertheless.
Several public banks are improving and changing. Some will get merged. The real issue here is asset-quality pain which is, to a large extent, a cyclical issue and it should pass in my opinion. In 2001, we were in a very similar situation. State banks’ gross NPAs were close to 15%. Today they are lower than that. Steel industry was in a mess then because customs duties in India had been brought down from 100% to 20% when the economy opened up in 1992. There was no capex. If you bought these banks then they went up nearly 10 times in the next eight years from the bottom. I am not saying they will go up again 10 times but directionally, we are in a very similar situation.
Finally, banking and NBFCs is not a business where market share is very important. Banking is a business of sensible underwriting, lower cost of funding and low operating cost. There are several banks and NBFCs even in the private sector that are very small but they are doing well.
One sector that nobody talks about and it is supposed to be very crucial for economy, jobs and all, is real estate. Demand has been weak, PE money has been coming, but there have been mixed signals... That’s a valid point and that is one segment of the economy which is quite weak and the reason for that is simple. In 2005, the rental yield in Mumbai was 9-10%. The mortgage yield then was 8-9%. So your EMI was equal to your rent. So houses were very affordable. Today if you look at Mumbai, the rental yield is 2% and the mortgage yield is 8.5%. So your EMI is three to four times that of rent. It is very difficult for a middle class person to buy a house. A similar situation is there in most cities in the country. And that is why the real estate sector is weak. That’s the reason the government has intervened by bringing in the interest subvention, both for middle class and lower class. It is basically to bridge the gap between EMI and rent. So in my opinion, one will see pick up in affordable housing segment because the intervention makes it affordable for the customer.
Do you think young customers are now coming back to buying houses? In the affordable segment with the subsidy from the government, activity is picking up. We can see it in the disbursements in this space. It will happen because the latent demand in India is massive. The bottleneck is affordability, but once you say I give you so much subsidy, the gap is bridged and you will see demand. It’s a peculiar position because the property rates are not coming down... They are coming down slowly. Rates not going up for five years is also coming down. Time correction is significant. In real estate, prices are very sticky because you look at your society if a house sells for ₹ 3 crore, the next seller wants to sell for more than that, he will wait for five years and not worry about the interest loss. But now he is unwilling to accept a lower price. So, that’s how we are. Therefore, prices fall in real estate very slowly.
What does the current retail investor behaviour tell about the market? You have seen so many cycles. You normally see a rush always at the end of every cycle, is it different this time? I think what you said is correct directionally but it is wrong to say this is the end in my opinion. If you look at the flows — the industry is getting ₹ 15,000 crore a month that is $2.5 bil- lion a month it is $25-30 billion a year, it is large compared to the past. But it is nearly 1% of India’s GDP and 5% of household savings. If you look at previous cycles, the peak was hit when multiples in the market were 25-30 times and the flows to equities were near 10% of our household savings. I think that cycle will repeat eventually. Such cycles have been repeated globally. But I don’t think we are near that situation. In fact in the long run, one can argue that allocation to equities should eventually move above 10% of savings as has happened in several developed markets.
Where are you investing your incremental money? You will agree that valuations might not be expensive but certainly they are not cheap either... I have a different view. Let’s look at markets factually. We are in August 2017. In three months, markets will focus on March 2019, and markets are trading near 16 times March 2019, which is reasonable.
Besides, now, where are the maximum downgrades taking place? It is in pharma, FMCG. It is not in banks or metals companies. Earnings composition and growth is undergoing a transition. It was banks and metals which were leading the downgrades earlier and now they are leading the upgrades and downgrades are happening in FMCG and pharma.
Let’s focus on the Nifty as that is where bulk of the market cap is; barring FMCG and may be pharma there are hardly sectors where think multiples are materially rich in my opinion. It is incorrect to look at 10 or 20 isolated companies that are at high multiples and form a view that markets are expensive. Instead, we should ponder which are the sectors other than FMCG and pharma in Nifty, where multiples should fall by 20% . Why I’m saying 20% because 10% is judgmental in stock markets. And I feel such sectors are very few!
Private banks? These are expensive, but that’s the way they have traded for a long time. This segment also represents one of the best quality and growing sectors. Besides, this is one sector where almost everyone is positive. I am not implying that a 10% or so correction cannot be experienced but one needs to differentiate between a moderate correction and significant overvaluation.
Is there a sort of a bubble building up in these NBFCs mainly housing finance businesses? There is an excess in my opinion in several NBFCs. But this is not applicable to Nifty as these companies are not in Nifty.
What’s the future of heavy-engineering companies? I think we are moving towards a period of robust growth in infrastructure/capital expenditure. However, we have to be patient as in the real world — unlike the financial world — things take time to change. Roads, railways, power, T&D, ports, airports and urban infrastructure, metros — all these have very good pipelines. The Uttar Pradesh government saying it will give 24×7 power by December 2018 to everyone means a lot. It means that the debate has shifted from free power to quality of power. Other states will have to do the same. That means massive investments.
Do you think earnings growth can go back to the mid-teens kind of growth rate? Despite the weak earnings growth, for one reason or another, I feel we are entering a period of strong earnings growth over next few years. Earlier the pain was in banking and metals and now it has shifted to pharma, FMCG and IT (what a role reversal! ) I feel growth will be robust 2018-19 onwards.
How difficult it is to generate alpha in these markets? Today, even in developed markets there are talks of moving into passive fund asset management. We need to understand how alpha is generated in markets. Let us say all of us in this room represent 100 % of the market. If the market capitalisation of India is ₹ 100 and all of us in this room own India’s market capitalisation. So if one person in the room earns more than the index it means someone else in the room has made below average returns. The sum total of market returns is what the market generates. Alpha means someone has to generate negative alpha also.
In the US, mutual funds own roughly 40% of the market. An additional 2030% of the market might be owned by promoters. Mutual funds are thus a very large part of floating market capitalisation and it is therefore difficult for 40% of the market to outperform. But in India mutual funds own only nearly 5% of the market capitalisation and nearly 10% of floating capitalisation. Thus it is easier for mutual funds to generate alpha but eventually a time will come when alpha generation will become progressively difficult.
I think this year though is challenging. this is so because large cap companies are doing well and sectors that were underperforming earlier are doing well and vice versa.