Do not see correction of more than 4-5%: Dron Cap

While Indian market has still not managed to surge significantly after touching 5-month high on Aug 21, some experts are considering it as a countdown to bull market. Benchmark indices have already climbed around 15% so far this calendar. However, outlook for Indian market still seams to be bleak. As policy paralysis is keeping investors at bay.

On an optimistic note, Pathik Gandotra, Dron Capital Advisors LLP feels that the correction is not going to be more than 4-5%. In an interview to CNBC-TV18, he said, "I am not saying that as a whole you will not see more than 4-5% correction even if - there should be something really drastically going wrong like the breakup of the euro in which everything will fall but if that does not happen bad news here in there will not cause a big correction in the market." He also stresses that risk reward is still favourable for Indian equities. As an investment strategy, he is bullish on IDFC among NBFCs and bearish on PFC, REC. Q: How is the risk reward position after the 7% upmove in August? A: I still think it is pretty okay because you have to be stock specific now. You can't just be bullish or bearish on the market. I think you should be actually be positioned on stocks where you see earnings visibility or policy visibility. Even if they turn a trifle expensive, I don’t think that should be a problem. On the other hand, till you see clarity on policy, very cheap stocks like infrastructure stocks will continue to remain cheap. I don’t think any amount of valuation buying will come in any time soon. Q: You don’t see any valuation based buying happening in the beaten down Bharti either? A: Bharti is a different thing. Bharti is a large cap. The extent of policy problems in Bharti is much lower than in the case of say a GMR or a Lanco where it is a matter of survival. So, valuation based buying can come into Bharti definitely. Q: Do you think the market may continue to ignore the weak macros? A: The market is ignoring the weak macro. The government had promised that after the presidential election there would be some news on policy, but nothing happened. The new finance minister has come, still nothing has happened. There is still only talk and there is no action on the ground. So, there is a whole section of stocks which are linked to that kind of policy action which have not moved. I think there is a case of serious polarity in the market. So, what is good will remain going up with inflows coming into the market, and what is uncertain, will remain beaten down. Q: Will this continue only in an environment where global flows remain supportive or if that risk-on comes off, do you think investors will stop ignoring the macros? A: It will. I don’t think that is going to happen which is why I think the downturn of the market itself is limited. I am not saying that as a market, you will not see more than 4-5% correction. Even if there is something really drastically going wrong like the breakup of the euro, it will not cause a big correction in the market. So, I think you are secularly on the path of moving up. Having said that, I just voiced my concerns about the government but the issue is that over a period of time in 3-6 months, they will have to dissolve it. If you don’t resolve the problems along coal allocation and other issues continuing the power sector then you will have a fresh round of defaults starting from the same time next year; that will be an even bigger blow for the country. _PAGEBREAK_ Q: Given the prospect of defaults, would you take a contrarian value based call on some of the beaten down public sector banks or is it best to stay away? A: It is best to stay away. I think I will buy PSU banks only when I am clear that the interest rate cycle is going to turn. This means it will start where I forecast that interest rates will fall very sharply in the next 6-12 months, I don’t see that happening today. So, maybe you can take a call on this sometime around December and January and not before that. Q: Are you saying it may not be too prudent to take big contrarian calls of getting into real estate, infrastructure, PSU banks and maybe stay with the outperformers? A: I would say that. But within the infrastructure space, you might still find a good quality company, like in the real estate space, Sobha is a very good quality company which has done well. So, I would look for serious quality within those places where I am clear that the risk of the overall negative macro will not play out on them. There are quality companies like that in the infrastructure space. Q: Where do you stand on Reliance? For the first time in many months, we have seen some optimism, do you think it is justified? A: Yes, I think so. But quite a bit of it is in the price. The stock has done well. So, the stock can give another 10% from here and then it will be all priced in. There is a temporary rebound in refining margins. So, obviously, that’s positive for the stock. There has been some talk of resolution on the KG-D6. Also, their Shale gas assets, over a period of time, will start contributing to their EBITDA, which is also what is getting increasingly realized by the market. But I don’t see a big run there. I think another 10% run in Reliance is possible. Q: Any thoughts on IFCI and the debacle of the last couple of days? A: I don’t know why institutions like IFCI should actually exist. The issue is that it is an NBFC owned by the government, it has done its role of term lending in the past. Without a banking licence, why should I even look at IFCI? I would rather prefer to look at PSU banks if I were to. So, if the stock is drifting down I guess that is where it should be. Q: Any thoughts on some of the other NBFCs like SKS Micro and Manappuram, which had a terrible ride over the last two-three months but have bounced back? A: There have been a regulatory issue with these two companies. Given the fact that the SKS Micro stock has got capital and the valuations were cheap, it did do its run. But I don’t think the risk has still gone away on microfinance because the point is that there are elections round the corner. Even if RBI puts out a regulation saying that it will supersede everything, the issue is that the whole payment culture in that business has been shaken up. It will take some time for it to resolve. So, what will happen is that those people need to start borrowing from moneylenders at significantly higher rates for the government to again start feeling that they have to promote microfinance. _PAGEBREAK_ Q: What about Manappuram? A: On Manappuram, the issue is slightly better because there was a problem there that RBI had about their fixed deposit raising and there is a policy issue on securitization. So, Manappuram loan book will have to go through its logical trajectory of first declining and then stabilizing before it starts slowing. But Manappuram will not grow the same way that it grew in the past five years because that will clearly create significant discomfort with RBI. So, my view is Manappuram’s historic peak valuations are of the past. But the stock can still do well after consolidating a bit at this level. Q: What about some of these government owned NBFCs like PFC and REC? Would you be bullish on this space? A: Absolutely not. If I have to be bullish on infrastructure finance company, I would be bullish on IDFC. That’s where at least you have asset quality comfort and there actually you can expect a reasonable ride once there is some clarity on policy reforms. I would not be bullish on REC and PFC. Q: The one space which has done remarkably well is pharmaceuticals. Are valuations expensive there or do you think there is headroom? A: The company at the top is Sun Pharma, where valuations are expensive. But then, there are obviously big opportunities that the space is presenting for generics in the next two-three years in both orals and injectables. And in that space, there will still be a rerating of the stocks in the middle to lower end of the market cap spectrum and where serious returns can be made. Q: Where do you stand on autos at this point? A: I would prefer buying auto ancillaries and autos. So, Exide, for example, is a very good stock to own. We would be more bullish on auto ancillaries at this stage. Once you are clear that interest rates will fall, one would start taking bets on auto. That time is coming but you are not there yet. Q: Any valuation based call that you are tempted to make on a BHEL? A: No. Q: What prevents you? A: Again, the issue there is of significant competition there and we don’t believe it is a very competitive company depending upon its tariff protection for its business. So, I would not bet on BHEL. Q: Do you buy the current optimism on cement? A: There was a correction in cement stocks post the mild correction and the competitive commissions report. But I think the cement industry will do okay because housing activity has still not stopped. I think housing is an industry which is doing pretty well so I would be bullish on cement. 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