Dec 12, 2012 04:18 PM IST | Source: CNBC-TV18

Mkt optimistic; see more upside in 1-2 mths: Motilal Oswal

Raamdeo Agrawal, joint MD of Motilal Oswal Financial Services believes the market is in an optimistic frame of mind and he sees more upside from its current levels in the next one to two months

The recent buzz about IPOs, whether it is with regards to the latest CARE issue or the Bharti Infratel one, the market seems to be on a high and stock buying is back. Raamdeo Agrawal, joint MD of Motilal Oswal Financial Services believes the market is in an optimistic frame of mind and he sees more upside from its current levels in the next one to two months riding on positive announcements from the government and the pick up in interest in the primary and secondary market offerings.

Also read: Mkt holds surprise; 2013 to build up for bash in '14: CIMB

At the moment, NMDC's issue also looks attractively priced and therefore, Oswal advises investors to subscribe to the IPO. As far as the third quarter earnings are concerned, he does not expect significant surprises. The Reserve Bank’s monetary stimulus is also likely to aid earnings growth and this would support the market rally, he added.

Besides, Oswal feels stocks like ITC and TTK Prestige has been the biggest wealth creator in the last five years. He opined, their business strategy and strong franchise have comprehensively led to their outperformance. Moving ahead, he believes consumer facing niche franchises are most likely to outperform. However, companies like Bharti still faces significant challenges in Africa, he noted.

Here is the edited transcript of the interview on CNBC-TV18.

Q: What is your view on the market? Do you think enough is done for the year or do you see the market moving higher in the next couple of months?

A: The sense is that the market is going to move higher because if you look at the market after the TV18 issue, it was around that time and now with the CARE issue, there is suddenly a lot of buzz about buying stocks and applying into IPOs. I think the mood is very good and I do not see any major disappointments at this juncture from any side. Earnings for the quarter is over and Delhi is making more announcements in a positive direction. My sense is that we are likely to move a little higher in the next one or two months.

Q: What do you make of the NMDC offering? Does it look attractively priced?

A: It looks absolutely attractive. It is monopoly and we are now almost falling short of iron ore and we being a huge exporter, our companies are becoming dependent on iron ore. I think government will be happy to give incremental licenses or leases on the iron ore mines of this company. So at six to eight times, it's an attractive offering.

Q: How about the Bharti Infratel issue?

A: It is much more asset incentive kind of an offering with an assured business and good infrastructure for the telecom sector. Of course it is not going to be a multibagger kind of a company like the way Bharti was offered at Rs 45 and in the next three years it went to Rs 1,000-1,200. It is not that kind of a thing because it is not a network with the power of almost unlimited capacity which benefits a company. It is much more asset intensive, so the gains should be modest but it is a very sound and assured business offering.

Q: Some people point out that the market could be setup for a bit of a shakeup come January and there will be disappointments in the earnings season again, is that you premise as well that January may see some correction based on earnings disappointments?

A: I do not know how the markets will behave but, I do not see too many surprises in the December quarter earnings, that is the ones to be declared in January. So I do not see any reason for a disappointment between September and December and do not expect any major thing to happen. I do not see any major hiccup in the earnings per se but, markets could be influenced by many other factors.


Q: How are you positioning your portfolio for next year now? Do you have a cyclical bias or a midcap bias as you look into next year or are you still staying with a relatively defensive portfolio?

A: That is where the 'Wealth Creation Study' comes into picture and to position the portfolio, most of the time I am fully bought so it again comes down to this 'Wealth Creation Study' where we have tried to give a continuing theme of picking winners and how to go about doing it. The portfolio will definitely get repositioned because of this ‘Wealth Creation Study’.

In this year’s subject we have picked up slightly difficult and more academic types but, economic mode is a competitive advantage and the role of competitive advantage in creating wealth in the stock market is the subject we have picked up this time. The economic mode fountainhead of wealth creation is the method we are following this time. This is going to shape up at least my portfolio. We have been doing that kind of themes earlier also but, now it will be far more sharply focused.

Q: From your Wealth Creation Study it appears that TTK Prestige has emerged as the biggest wealth creator over the last five years. How does it tie-in with the Economic Mode theory that you were talking about, how does it ensure that TTK has done so well?

A: The largest wealth creator is ITC with almost Rs 118,000 crore of wealth creation in the last five years and the fastest wealth creating company is TTK Prestige which has grown at the rate of 89% compounded in the last five years. So the largest wealth creating company is ITC and the fastest wealth creating company is TTK Prestige.

Both of them incidentally are consumer franchises; one is in the small home appliances sector and the other is of course a 75 to 80 percent dominant cigarette company in India. There is something happening in the last five to six years, the dominance of consumer companies have clearly increased over the commodity companies.

If you see the last eight to ten studies before this, it was oil and gas for eight years; for five years it was Reliance and three years it was ONGC as the largest wealth creating companies and both of them are out of that list of 100. In the meanwhile, a lot of consumer companies have come and Hindustan Unilever (HLL) has made an entry in the list of not only 100 but, has made a position amongst the top ten companies after a lapse of almost ten years.

I think consumerism in the last seven years is reflecting in this wealth creation study as the dominant force.

Q: The theory that you were talking about also stresses on how companies can shield themselves from competitive attacks. Do the two cases that you mentioned, ITC and TTK demonstrate that in terms of strategy?

A: Yes, clearly. If you look at the components of strategy, they are very unique in their value proposition. Clearly ITC is very focused, dominant and they have that scale and the branding power. We did not mention that it is the lowest cost producer because of the scale but, clearly ITC is very focused and is a very unique offering in the cigarette space.

It is the brand leadership of TTK Products in the home appliances segment that has led to its success. Clearly they have very unique positioning for their products. I think the main thing is that they have to be very unique and they are approaching the consumer needs in a very different way. To the best of my knowledge, both the companies are unique in their own categories and are highly profitable. If you look at their franchises, both of them do not have any kind of capital requirement. So their return on equities is almost 100-120 percent.

I think both are extremely profitable and of course TTK Prestige was not as profitable 7 to 8 years back but, I think something has happened about the rural demand for their product. That has led to a massive upsurge in demand and changing the quality of the franchise of profitability in the last 7 or 8 years.

Q: Would you say also that your study has indications on what potential wealth creation could happen in the future, for example, for stocks like ITC and Hindustan Unilever? It has also been a function of the market cycle where defensives have outperformed because that has been the nature of the stock market cycle we have been in, is there a guarantee for the kind of performance we have seen for the last five years that these could be the stocks to bet on going into next year as well?

A: As far as individual stocks are concerned, company specific events does matter but, if you look at a basket of these so-called unique companies, companies with a very clear strategy, these companies irrespective of the cycle have done significantly better than a set of companies which do not have a strategy.

We have tested that from 1995 to 2012 in this report and from 2002 to 2012. So we are talking about one down cycle and one up cycle. If you look at the returns on the companies which have a strategy from 2002 to 2012, these kind of franchises have literally given 22 to 23 percent kind of returns, whereas the other companies i.e. the rest of the pack has given just about 11 to 12 percent return on Nifty also. We said about 23 to 24 companies have these franchises and the other 26 to 27 companies did not have these very clear strategies defined, as far as this particular set of tests are concerned.

If you see the return, they again match up with this and almost double the return from franchise companies. My sense is if you have a set of these companies in your portfolio, they will do very well.


Q: As a sector, financials have emerged as the largest sector and the last five years have seen the breadth of financials available in the market and it has also expanded. What leg of it has performed the best between the private banks, non banking financial companies (NBFCs), a couple of public sector undertaking (PSU) stories?

A: This has been an important segment. In the last study and this one also the financials are emerging as the largest wealth creating group, almost a quarter of the wealth has been created by 25 to 30 banks which have been listed. My sense is that licensing has been so stringent and the opportunity size has exploded so much in the last five to seven years in India that even a very mediocre bank has done well.

Actually the worst performing bank is also beating the index and the ones which are doing well, whether it is a private sector bank or the best of the public sector bank, are growing almost at the rate of 25-30 percent compounded. This is one segment of market where you just cannot go wrong. Even the worst performing banks will give 15 to 17 percent return.
I think banks have been one of the very positive surprise findings. So long as the government keeps the entry barrier very high, they do not give new licenses. I think competitive situation for an ever exploding banking opportunity remains huge for the banks which are operating in the current scenario.

Q: How would you use this study to tailor your portfolio or your approach to the market in 2013?

A: I think understanding that whether the company is unique or not to fight the competition and whether to look at the components to say whether the company is unique or not is required for tailoring the portfolio. One of the things is that the uniqueness is demonstrated through their past performances and typically, the unique companies continue to remain unique for many years to come.

So once you find a unique company like HDFC which is very unique in its mortgage business or TV18 which is unique in its business news segment. In case of these companies, the lock is so long and strong that it is very difficult to break in the near future. Actually having a company with a unique value proposition upgrades the needs to know the future because the stretch is so high or so large that it continues in the future.

In the stock market, the future is more uncertain but having a company with a successful strategy requires you to have a point a view. That is sufficient. For example, mortgage market is going to become big and after that you do not have to worry about whether it owns HDFC or something else. HDFC is a clear leader. It is the world’s lowest cost processor of mortgages. So if you buy into HDFC today and it has done very well in the past, I think they have continued a reasonably good performance and is kind of an assured bet.

But just talking about one company may not be right. If you have a portfolio of ten companies, one or two may disappoint but as a portfolio you will do significantly better than the set of inferior companies. You will also do much better than the index itself because the index has a lot of competitive advantage companies.

So despite having a high competitive barrier you will still do better than the index, maybe looking at what is the performance of index in India you are looking at 22 to 24 percent kind of compound return which is handsome by any standard.

Q: In the past on panic sell movements, you have always advised buying into the market. This time it is different. We have been through a very tough five year cycle. Now people believe there is some kind of troughing out happening. Is that the approach you are going into next year with that it could be the nascent building of a bull market era?

A: It looks like that. I am not saying technically, but if you look at the fundamental base of the market, somehow despite major slowdown in the GDP we have not seen major earnings crackdown. The sense that earnings growth has definitely slowed down between 2003 and 2007 or 2008, was more like 25 to 27 percent compounded, which is unprecedented.

But, now it is more like 10 to 12 percent, 8 percent but it is rock solid on a very higher base. We are talking about Rs 1,200-1,225 this year and Rs 1,325 to Rs 1,350 next year. That tells me that earnings broadly, with a percent plus or minus could depend on government policies or interest rates but, broadly earnings and valuations are intact because the earnings have grown by almost 50 percent in the last four years and markets have corrected. The valuations are also reasonable at 50-50.5 times.

Once the interest rate cycle starts turning down in the sense, which maybe in January or March, but if you look at the next 12 months, interest rate will be somewhat lower, maybe 100-150 bps depending on how bad is the slowdown. So my sense is that at a reasonable valuation and imminent fall in the interest rates and slightly positive global environment, probably we are headed into a new zone, pass 21,000 in the next 12 months at some point of time. That is my feeling.


Q: You spoke about HUL. Bharti was such a big outperformer and if you look at it till five years back and then it has had a huge compression in valuations and stock prices. Is it conceivable that Bharti might become a big wealth creator again or do you think its best is behind it?

A: I would think at this juncture, to the extent I know, the best is behind it because of two things; one is that the industry structure has completely changed from five to six players it has now become 10 to 15 players. Still everybody wants to stay put and somehow make it to the next decade or something like that.

Secondly, the company has allocated bulk of their balance sheet, almost 50-60 percent of the balance sheet to Africa where returns are not only low, it is actually negative at this juncture. I am sure they will earn something but, to get to 15 to 20 percent kind of a return is going to be very tough on purchase price of the African venture. A lot of things can change in future, it’s a technology oriented business but, at this juncture I do not see a lot of excitement in the next 12 to 24 months.

Q: There have been some companies in the auto space like Bajaj Auto or maybe even Mahindra and Mahindra (M&M) which have created some wealth for shareholders over the last two to three years. Can you think of a name which fits into this kind of wealth creation definition that you are working with?

A: Yes, all of them. Actually the very obvious names keep creating wealth whether it's Asian Paints, HDFC, HDFC Bank, Bajaj Auto, Hero MotoCorp, Hindustan Unilever (HUL) or Nestle. All these big names sound very expensive at this juncture but, what happens is that the market assesses a life longevity of a company for 20 or 25 years. But, after five years they again say it is 25 years. These first five years assign a value for the next 25 years but, the longevity of these companies are so good and if it is growing we call it capital advantage period.

This cap keeps shifting and that is why these companies keep making money and every time after five years you realize that not only the cap is shifted for the next 25 years but, even the size of the value, the money it could make in the next 25 years actually goes up. That is how blue chips keep making money and my sense is all these unique franchises, particularly consumer facing ones does the same because in the last five years the economy has moved from a trillion to two trillion.

In the next five or six years, the economy will move from two trillion to four trillion, maybe three-and-a-half trillion given a year here and there but, the consumer consumption boom on every segment is going to be much bigger in size than what we have seen in the last five-six years. These franchises are not replicable in any segment in the next five-six years because the nature of their uniqueness is so strong that it is impossible to build another Cadbury, another Bajaj or another HUL in the next five-six years.

So bulk of the growth will benefit these companies. My sense is all these strong consumer facing franchises will do better than the market despite their high valuations right now. My request would be to stay put in the portfolio about these companies.

Q: Where do you stand on some of these anti consensus stories. You are with wealth creation but would you say it is also a good year to start picking some of these dark horses?

A: I would not pick into any one of them unless I am very clear about their delta in earnings. Just because they are very cheap they might be cheap for very right reasons and worst might be ahead for these companies. But, the companies which are down because of some media reports or something and actually their underlying business is doing very well, I would look into them.

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