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Mar 17, 2017 03:52 PM IST | Source: CNBC-TV18

Don't rush to participate in market, choose good fundamental picks: HDFC Sec

Dipen Sheth of HDFC Securities recommends looking for fundamentally strong stocks, even if it means looking outside the index ones. He is upbeat on Repco Home Finance and TeamLease Services.

Bulls took charge on D-Street through the week as the market saw a firm rally. Equity benchmarks have clocked fresh record highs, with the Nifty even touching the 9200-mark on Friday. Domestic inflows were steady on a higher influx of money in equity mutual funds as well.

While the market remains at an all-time high, investors must not be in a hurry to participate but look for good quality stocks, Dipen Sheth, head of institutional research at HDFC Securities told CNBC-TV18 in an interview.

“Most investors will begin to panic on the feeling of being left out,” he said, adding that such investments then drive up the market sometimes. Instead, he says, one must look for fundamentally good picks. There are options available outside of the index as well, he stated.

Among midcaps, there are many good stories coming out of there. “The focus should be on bottom-up stories… there are stocks at good valuations in the space” he told the channel.

Among sector-specific picks, he was upbeat on Repco Home Finance in housing finance. “The stock has multiplied investors’ wealth and there is years of growth still left in the stock,” he said, adding that the firm has mastered the model of lending to non-salaried class. The stock looks attractive at 3 times price/book. Furthermore, he recommends looking at some high-quality NBFCs which are trading at cheaper valuations now.

Sheth is also positive on new age businesses such as TeamLease Services. He expects the company to double earnings before interest, taxes, depreciation and amortisation (EBITDA) over the next two years, driven by growth leverage and improving margins. On the growth front, he foresees many years of 20-25 percent growth as the industry is under-penetrated.

In specialised segments, he cites cases of Navin Fluorine and Vinati Organics, which according to him are high-quality businesses. He recommends looking at such chemical companies with high return on capital employed (ROCE).

Sheth also sees potential in home improvement space. As Indians are increasingly spending big amounts in decorating homes and financing them, plywood firms, housing finance and appliances will perform well.

Below is the verbatim transcript of Dipen Sheth’s interview to Anuj Singhal, Latha Venkatesh & Sonia Shenoy on CNBC-TV18.

Anuj: The market has had a one way rally of course over the last few days. Are there enough stocks even at current valuations, current levels which deserves a buy? I mean I am asking at the index level?

A: I am happy you asked me this specific question. So, yes, market is at all-time, we are in unchartered territory, so all the technical blocks are now saying we are going to zoom up. The guys who look at the numbers and watch out for macros are advising caution. The money keeps flowing into mutual funds, give or take a few percentage points every month.

I think at this point of time most investors will begin to panic on the feeling of being left out if they aren’t invested substantially that is typically what drives up the momentum at times like this. I think that is something we should completely advise investors against; don’t be in a hurry to participate, find fundamentally good stories and there are good stories outside the Index. I don’t see why you should confine yourself to the Index.

However, people are now calling for a bubble but all midcaps are not bubbly. There are whole lot of good stocks out there, go and do some bottom-up investing. Don’t look for topdown themes right now. The biggest topdown theme there is this playing out which is getting into – we got into five years of arguably better governance then ever in the economic history of this country and hopefully after the UP elections most of these pandits who got it wrong will now turnaround and say but we should get another five years of good governance.

So, that is the top-down theme that you should be focusing on. But, if there is a bottom-up story I think there are several bottom up stories which are available for affordable valuations and which offer multi-year growth. If you look for some of them I have written to you about a couple of them and if you allow me the opportunity maybe we can talk about them in more detail.

Latha: Housing finance obviously, that we discussed some of those stocks, what would be your choice?

A: In every sector and similar is the case with housing finance there is a spectrum of companies across the entire you know market cap spectrum if you want or in terms of the customer class or segmentation they service and so on.

We have been looking at, already this stock is a multi-bagger of sorts and yet I see it being a continuous compounder for a many more years to come. They have gone through a stumble, so they were quoting at almost four times price to adjusted book on and FY19 basis and which we thought was a little unfair.

Now they have come back to about three or so. I am referring to Repco Home Finance which has of course multiplied investor’s wealth after the IPO. But, here is a company which has got a sub Rs 10,000 crore book, and there is years and years and miles and miles of growth still left.

They went through a little bit of shudder post demonetisation when non-performing assets (NPAs) short up. They are still elevated, that bucket of 30 day plus overdue is still running high close to 15 percent. We think it is a very solid management. They have got it completely under control and it is going to fall-off over a period of time. That is the call we are taking here. So, at three times book I think it is – so if you look at all the policy drivers so for affordable housing, infrastructure status for developers the unique thing about Repco is not just the policy drivers which will come in, so Pradhan Mantri Awas Yojana and all that but more importantly a substantial part of their book goes out to what is the non-salaried class and that is the difficult part of the business

to be.

We have seen Equitas Holdings going through a little bit of stumble on that kind of lending. It is not so easy to step-up a housing finance company and scale it up to this level and keep on continuously scaling it up especially, if you are lending to the non-salaried class where appraisal cycles, recovery capability, loans to values etc. offer much more of a challenge. They have kind of mastered it, they have gone through a stumble I think they are going to pick themselves up. So, three times book and I am saying buy them for 10 years.

Sonia: The other stock or the other company that you recently went and met is TeamLease Services, interesting there what caught your attention and why would this be a good long-term call?

A: We picked up this mission in life so to say to cover what we call is a new age business and TeamLease is clearly a new age business. When we say new age business we mean that it is kind of business model which wouldn’t have existed let say 10 or 20 years ago in this country and hence because it is a nascent and evolving business model there is 20-30-50 years of evolution and scale–up possible in the business or in that industry.

What do they do? They do flexi staffing. They provide temporary workers to people. Now you might say what is the big deal? The big deal here is that globally anywhere between 1-3 percent of all workers in the organised sector are anywhere on a temporary basis because use that to get over fluctuations in labour demand because of seasonality or because of ups and downs in the cycle.

You end up paying a little more but then you have done that demand management and you don’t want people on our roles for so long. So, temporary staffing or body shopping is the way IT companies has grew up out of India to begin with. That was only for the IT sector and then it became more and more of a specialised business model.

Now there is a whole lot of industries or sectors in India which are growing and which need people. They need people at short notice and they need to have flexi people or flexi staffing so to say. This is a fairly new phenomenon in India, just about 0.50 percent of our organised work force is in flexi staffing versus 2-2.5 percent globally.

Within that 0.50 percent about 70 percent is provided by unorganised players. So, all that urbanisation, industries like retail construction, retail finance, e-retail all of these things moving up is leading to demand for this company. In the last two years they have doubled their EBITDA. In the next two years I think they will double their EBITDA all over again.

Anuj: If I am not wrong you have tracked some of these chemical companies like Navin Fluorine, SRF etc. anything that is still a buy at current levels or has the story played out?

A: We have seen a little bit of a, I won’t call it a correction but easing in Navin Fluorine and in Vinati Organics. In both stocks our internal house feeling is that these are very high quality businesses. It is very easy to label every chemical company as a commodity, so cement is also a chemical and it is a commodity of you ask me or soda ash is a commodity. The stuff that Navin Fluorine makes or the stuff that Vinati makes and the kind of product pipe that both these companies have is very exciting and both these guys are into specialty spaces.

When you are in speciality space you are not going to face pricing pressure provided you have picked the right chemical, provided you got a unique way to make it, provided you are one-off maybe two-five or ten manufacturers globally who can do it and that is how you will maintain your margins that is how you will maintain your return ratios. Especially, in the case of Vinati for example here is the management which has selected not one or two but dozens of chemicals over a period of time so they have got 5 or 6 chemicals currently make-up the bulk of their revenues.

The next two or three years at Vinati for example present incredible opportunities for a lot of specialty products where there will be one out of two or three or four or five manufacturers globally and each of those chemicals feeds into pharma or water treatment or specialty or polymer spaces which are growing. To my mind this is how one must look for a chemical company that does it have a portfolio of high Return on capital employed (ROCE) chemicals.

Latha: Home development or home improvement, Astral Poly Technik is one stock that has been moving or would you want to discuss that one or any other of the home improvement companies?

A: We don’t have many of these companies under coverage, so I am constrained. I can give you a take on the space as such so again when we see urbanisation when we see pricing aspirations on a low base I think Indians are going to spend and invest an incredible amount into making, decorating and building their homes and financing them. So, the opportunity for housing finance companies, the opportunity for let us say plywood companies, tiles companies, anything to do with home building is going to be high and of course the opportunity for appliances companies. Right now we have coverage on appliances companies. It is difficult to build brands and distribution channels there, so in that space if I may say so we are very bullish on companies like Crompton Consumer for example.

Sonia: Wanted to get your view on the biggest Nifty gainer – I mean we can’t take our eye of that ITC? It is up about 5.50 percent so now GST will be tax neutral for cigarette companies which is a big relief. But what hereon do you see this stock give you a lot of returns over the next say 6-12 months?

A: The structural story on ITC is split on two arguments – one that cigarettes are harmful, ultimately government is going to, and there is going to be regulatory pressure, the government is going to keep on increasing taxes faster than they can increase prices much of that has played out. The other incredibly long-term bull argument and you will see therefore ITC being held by the long-term investors such as insurance companies for example and that is that cigarettes still account for less than 15 percent of all tobacco consumed in India.

Look at the amount that gets into guṭka which is facing incredible or chewing tobacco which is facing incredible push back as more and more people get educated and aware. Look at the amount of tobacco that is consumed through beedi and we know there is this entire beedi baron politician nexus that keeps beedi out of tax net. How long will this happen with a government which is responsible, so I think the more confidence that comes back that this government is about fair play I think despite the fact that cigarettes are themselves not fair play in a morals sense, but relative to cigarettes there is whole lot of unfair play going on in the tobacco space, so cigarettes are a natural gainer out of that.

Anuj: Just one more check on NBFCs, we have seen a big move in names like Bharat Financial, M&M Financial of course housing finance as well anything that you would still buy?

A: Repco is an NBFC and I spoke about it so that is one. I think there is a whole lot of very high quality NBFCs out there. The guys who are good at understanding how to lend to the underserved segments and are good at appraising at credit appraisal and more so at recovery should things go wrong. So, I hate to repeat this stuff but if you look at headline NPAs being at 4 percent or so in Repco and get scared, but if you look at the lifetime write off, the loss given defaults that they take on housing book it is negligible it is less than 10 basis points historically so, that is the kind of thing.

There was a time when we began to assume this was true for Mahindra and the jury is still out on that especially as we get into drought season down south and how will their NPA so their headline NPAs are close to 10-11 percent right now if I remember. But it is again a very high quality management and I think over a period of time I am sure they can get their act right. If the story implodes then we are in serious trouble and some of that implosion if it were to happen god forbid, if it were to happen you may not be able to blame it on the management it is just that they are going through a terrible down cycle on their business.

You look at another company in this space where we have been bullish for a while and which has held its horses very well is of course Cholamandalam Investment and Finance Company and you have a range of players out there and you can go and take your picks. Some of these guys are trading pretty cheap right now.
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