Banking sector will grow but you have to figure out where the sunset of the leadership is: Motilal Oswal’s Raamdeo Agrawal

Raamdeo Agrawal says there is now strong certainty that the current government will come back

The stories for both public sector banks and private banks are different, says Raamdeo Agrawal of Motilal Oswal Financial Services Ltd (MOFSL). According to Agrawal, private sector banks are also facing leadership change challenges –- from transition time to strict regulations. “At the same time, the economy is flying, and there is massive competition,” he adds.

In Part 3 of his conversation with Moneycontrol, Agrawal spoke about opportunities for IT stocks, challenges of leadership in banking, and competition with China. Edited excerpts:

Also watch: Strategy 2024: Where To Invest? What To Avoid? Sustainability of The Bull Run | Raamdeo Agrawal

What are the principles you follow for buying into dips?

The first thing is that I am 100 percent invested at the top as well as at the bottom. That's my principle. I have never been in cash because it is beyond my capability to call the top and then sit through the entire fall and call the bottom. I think somebody can call the bottom, or somebody can call the top. Both cannot happen. And unless both happen, there's no point in calling. If I have Rs 100 crore, I will buy stocks worth Rs 100 crore. Within that, what stocks to buy and which sector to bet on? Those are the issues that keep us busy. But for allocation, I tell the client, if you are 50 percent in equity, be allocated 50 percent. Your risk appetite is for 25 percent, go to 25 percent. I have worked this way so far, and it has worked brilliantly for me. I've seen three cuts of more than 50 percent in my portfolio -- 1992, 2001, and 2008. But it is okay to see three cuts in around 40 years. But the beauty is that in one year, it comes back.

I remember in 2000, you had said that one of the learnings from that cycle for you was that you thought quality would sustain value. But even Infosys…

Infosys I sold close to 80 percent, near the top. But with that money, I bought junk, which went to zero and never came back. At least Infosys, after three years, came back. I would have been better off not doing that. That's a learning from the past.

In bad times, you like to compromise on quality. During that time, the good-quality stocks move first. And behind that, the lower-quality stocks start moving, and you want to be part of the action all the time. You start diluting your portfolio, and finally, whenever the dust settles, you have all the junk in your portfolio. The issue is that the trend is external, the liquidity flow is external, and I can do nothing about it. Instead, I see how I can take care of myself by sticking to my investment philosophy. If something doesn't fit with my philosophy, I may feel bad to see that a stock is doing well and that I don't have it in my portfolio. But that's fine. And second, is that it is not about the performance of one stock; it is about 100 percent of your portfolio.

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If the Chinese economy is unable to recover, is there a possibility of dumping, which could destroy a lot of industries here? Will that take away from our profits? 

Wherever you are competing with China head-on, you always have this threat. Even when you are doing well, there's always a threat that China can dump and finish off (India's) profits today. But the good thing is that in services, they are not there. Sixty percent of the economy is services. So, in all the service-oriented industries, or within manufacturing and even consumer goods, there's no competition. Competition is only in the industrials, tradeable industrials such as steel or other metals, and some chemicals. That's where the real competition is.

Till a few years ago, the specialty chemicals sector did well. But over the last one and a half years, the stocks have gone down 50 percent. Are these good buying opportunities?

Special chemicals, as a sector, are very company-specific. The question is, do we have a global competitive advantage? One of the problems is Indian cost versus American value. That's the beauty of Indian IT. You manufacture at $5, and you sell at $25. There is enough margin out there because you are competing with American producers, where $20 per hour is the minimum wage. There, the minimum wage for a competent guy is more like $60 to $80, or maybe even $100. Against that, you are giving hardly $5 or $10. You have a huge competitive advantage. But when you come to manufactured products like chemicals or steel, you are looking at Indian costs versus Chinese prices. There's also China's scale, subsidies, and other things. Even if an American manufacturer would like to shift from China to India, he would want a price that would be competitive with China for him to make the shift. How do we give a competitive price? The margin will always be a challenge.

When you're competing with China in terms of price, you might get the volume. Any buyer from Europe and America will prefer Indian products, but they want Chinese prices.

Is the use of PLI schemes to address these segments just a makeshift or tactical move?

Somewhere you have to begin; you have to get some basic volumes. The government is saying that they will fund the companies to manufacture in India, but do the stuff here, do the validation in India. But it is a challenge. The government plus Indian manufacturers — are they good enough to see the competition coming from China? Because (China) is very passionate and very organised, and they have scaled up. But you can't give up as a country. Getting a competitive advantage, a global competitive advantage, in manufacturing takes time.

How do you see the IT space, especially with regard to the risk from AI?

The challenge is for large companies. Mid-sized companies will be able to manoeuvre. The IT spend is not going away anywhere. If the world is growing at 5 percent, the IT spend is also growing at 5 percent. In fact, there's more pressure on the IT budget — they need to do 6 percent or 7 percent. Some of the IT leaders were asking, why should it be stuck at 5 percent when health insurance is at 12 percent? It should also rise because the need of the hour is digitisation. They are asking about a larger budget, and then with the Indian cost structure, the competitive advantage is so high that even with AI, which will make it happen for the companies, it's not going to happen. You have to go and implement those solutions. That will again be done by Indians. We'll be the best at executing AI.

Now the issue is that after using AI, the programming, and all those long-cycle projects, can it come down in terms of timeline, say, instead of 90 days, can it be done in 30 days or 10 days? If so, there will be demand. The demand for software is unlimited. So, when you bring down the price, the demand for the software will explode. So, the explosion in volume and the reduction in the cycle time for the software will work out brilliantly for the Indian IT companies as we go along. That's my sense.

Are you bullish on IT companies?

Not in the short term, but I am also not bearish. Also, I think they are wonderful companies, and we must have some portion allocated to the stocks. These are very high ROE, high free cash flow, extremely well-governed, professionally managed, and globally competitive companies. So we must have them in the portfolio.

What are your thoughts on public sector bank valuations now?

Till 2004-05, 55 percent of wealth was created by PSUs. Then it started coming down and became zero last year. So it had to reverse. In the market, value discovery keeps happening. If there was anything left out six months or nine months back after the first flush of the bull run, at the index of about 17,000–18,000, it was all the PSUs. And that's how the market went about discovering them. They were, in any case, (companies that gave) 5-7 percent dividend yield (at) PE multiples of mid- or low single-digits. If you can get any company at a PE multiple of five and it is a large, monopolistic company, what stops you? Clearly, there was the deepest possible value, but they were very unpopular for whatever reason. And companies, irrespective of their performance, kept on going lower and lower in value. But now it is reversing. The character of the PSUs will remain the same. Whatever their problems were earlier, I don't think they are getting sorted out immediately. But what the market did was also unreasonable with their correction.

How do you size up this opportunity between private banks and public sector banks?

The stories for both are different. The opportunity for private banks to win market share from PSU banks continues, but they have their challenges of leadership change. It takes some time for transition. And our regulators have been very strict on the old management, which I find challenging for the transition. These are all huge companies. For the new management, without the supervision of the old management, (things can be) very tough. And at the same time, the economy is flying, and there is massive competition. PSU banks have also come back. The books are clean. Now everybody's balance sheet is as pristine as can be, and opportunity is there. So they have their own liability franchise, so they are giving tough competition to private sector banks.

What looks good now in the segment… 

You have to go bank by bank. Somewhere you get good leadership, somewhere you get very low valuation, somewhere you get very good growth, etc. It’s a combination. The banking sector is going to grow, and you will get opportunities there. But you have to figure out where is the sunset of the leadership. That has become a new surprise, and that is taking the entire sector out. Because if the largest of the banks are passing through transition and they don't scale up in terms of valuation, then others can't scale up.

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