Banks at the forefront of liquidity driven rally: Envision Cap

Banks are at the forefront of the liquidity driven rally that is underway in the market, said Nilesh Shah, MD and CEO of Envision Capital. Even though the public sector banks are still plagued with asset quality issues, and private sector banks remain expensive, he holds a positive view on the banking sector."Private banks are expensive, but chances are they may get even more expensive with the tailwind of liquidity," said Shah.He said the buy back announced by Tata Consultancy Services is a very good start for the IT sector to return surplus cash to the investors, while also improving the return on earnings (RoE). Since IT firms are cash rich, a few thousand given out in buy backs may not affect the company much, he added.Shah said it is difficult to take a call on the entire pharma sector. He recommends investors to be stock specific. He points out two reasons why the sector remains volatile. One, is the weakness in dollar which can affect margins as pharma companies report revenues in dollar. Second, is the ongoing price erosion in the generic drugs market in the US.He finds the midcap pharma space attractive from a 2-3 years point of view.Below is the verbatim transcript of Nilesh Shah’s interview to Latha Venkatesh, Anuj Singhal, and Sonia Shenoy on CNBC-TV18. Latha: It is a big day in the sense that there is a new head at Tata Sons. However, before I get to what you expect from them and whether that changes your outlook on any of the Tata stocks, there was the big news of the buyback itself that came from Tata Consultancy Services (TCS). What are your thoughts post the buyback, what would you do with TCS as well as Infosys? A: I think clearly the fact that the technology companies have started to kind of initiate buyback, I think that is a wonderful thought process. I think it is a good start and it is probably the best way to kind of deploy surplus capital that you might have and in a way it just reflects the best or the most optimal way of returning excess cash to shareholder. So, I think at this stage you would probably just look at this is as just returning cash to shareholders and in the process marginally improve your return on equity (RoE). However, we need to keep in mind that these are really mega-cap companies and just kind of paying out a few thousand crore of capital towards buyback may not meaningfully change things and change the financial ratios for these companies. However, nevertheless, I think it is a good start especially in this current environment where there is some bit of volatility, uncertainty as well as complexity about the outlook for technology sector. I think in that context, this is a very good move. Latha: Just to continue with that, at the Nasscom meet we heard some damaging statements. The Capgemini head was saying that the current Indian IT setup is entirely unprepared for digital and it was speaking about even a possible redundancy of 65 percent in the middle and senior levels. Would you worry that Trump is a minor challenge but IT stocks in slightly longer run, would you worry about their ability to take the digital challenge, will you stay invested in them? A: Probably this statement I think is a bit alarmist. I think it is a statement which probably just over magnifies the challenges which the sector is facing. There is really no doubt that the sector is facing challenges and they need to basically transform and do that crossover from the conventional application and maintenance business to really the new business which revolves around mobility, analytics, cloud, and digital. So, clearly that crossover is required. Latha: Discipline on capital usage, shareholder returns, what stood out for you in the words that N Chandrasekaran had to say? A: I could hardly hear much of what he said but I think in the first place I wish him the best of luck and look forward to Chandrasekaran taking the Tata Group to a new high. I think clearly the responsibility which he faces as a group CEO, I think is practically the responsibility that any CEO faces which is more about addressing right opportunity, engineering growth, and then capital allocation. I think these are the three big factors which will essentially mark his career and that is true for any CEO when they are basically managing an enterprise. Clearly, I think the transition from being the CEO of the largest company within the group to managing the entire group, I think that transition is something which the market, the street and corporate India will clearly look forward to. So, it look likes that from what he has said, I think he has got his priorities right and clearly focus has been a hallmark of Chandrasekaran and that is very evident from the initial words that he said. Anuj: Let us talk about the rest of the market now. You have seen a huge rally in banking stocks, the Bank Nifty is at all-time highs as we speak. Do you get a sense that it has got its mojo back and that is the space to focus on for the rest of the year as well? A: I think clearly whenever we have seen liquidity driven rallies, clearly banking remains at the forefront of such a liquidity driven rally and it looks like that this time is no different. I think the challenges which the sector faces, I think remain. Public sector banks clearly still are dogged with the big issue of asset quality. There doesn’t seem to be yet a perceptible improvement there. Clearly the room for lower interest rates is not there as what the latest RBI policy has said. A lot of the treasury gains that they have been enjoying, perhaps may not be there over the next few quarters. So, it will have to be back to business for the public sector banks and that seems to be a daunting task. At present private sector banks are expensive, of course though they will continue to kind of grow at about the 15-18 percent band, especially the bigger private sector banks, but clearly valuations are a challenge. However, having said that, something which is expensive could get even more expensive especially if there is a strong tailwind of liquidity. I think as long as liquidity remains, banking as a sector could continue to perform.Sonia: This space that everyone regrets to not buy is the metal space. Most people I know have missed out on that rally. Are you one of them and do you at this point in time recommend that one gets into it or do you stay away? A: That is a very difficult space to be because you clearly need to have basically a perspective on where are metal prices headed and along with that how different countries are in a way protecting their respective sectors. So, I clearly believe that you need to be more focused on what is happening in China and rest of the world to really be able to take a call on metals and then of course get your price call bang on there. However, I think they have seen a very strong rally and that is also because they were significantly beaten down. So, over the last one year, they come out to be heroes but I think over slightly more medium to long term, they still have been in a way wealth destroyers barring maybe one or two names. So, I think clearly it is a space where as a long term investor you are better off avoiding, but obviously of course if you are that short term momentum player and a beta player, then obviously metals is a space you can’t afford to ignore. However, I think for long-term value investors, it is best to kind of avoid a sector like metals. Anuj: You have tracked the pharmaceutical space for long. We have seen a bit of a comeback for some of these pharmaceutical stocks led by the larger ones as well but in midcap pharmaceutical we have seen quite a bit of buying. Anything that you would want to buy right now? A: I think in pharmaceutical it is always hard to really take a sectoral call but individual companies out there, I think some of them are outstanding companies and have good growth prospects. So, clearly the way I would kind of look at it is that in the last few days what we have seen is some of the players have started to kind of get approvals or have started to have no observations post an inspection. So, probably the best way to lookout for or to identify some of these companies are companies which do not have issues of data integrity but have just had observations around their processes and the way they operate. I think clearly it would be a good idea to kind of look at those kind of companies and see if there has been a significant price shave off over the last 12-18 months and probably that is the best way to kind of look at them. We need to keep in mind that I think once the approval start, you would clearly see their revenue growth back in-line because some of these companies while their facilities have been under observation and have been under some kind of check, but they have been getting product approvals as well. So, I think the moment they get those plant approvals, the product starts rolling out in the US generics market. So, I think clearly that is a big opportunity there and we see some of these midcap pharmaceutical companies have become attractive post the price shave off that they have experienced over the last 12-18 months. However, keep in mind two things, one is basically they have dollar revenue. So, any weakness in the dollar could impact their margins. So, one needs to keep that factor in mind and number two is that as more and more approvals come in especially from a market like India, you would actually see continued price erosion in the US generics market which also could dent margins. So, I think one needs to keep in mind these two I would say challenges in terms of margins. However, having said all of that, I think the midcap pharmaceutical space looks very attractive from a two to three year perspective. Latha: You have a keen eye for even consumer durables. Symphony is one of your great picks that did brilliantly well. We just spoke to Asian Paints, they did sound still very downbeat about having consumption demand fully recovering after the demonetisation blow. How do you look at your consumption portfolio for 2017, would you add on to any or would you stay away from that space because after demonetisation you are going to have probably a goods and services tax (GST) disruption? A: I think that is a pretty interesting area because clearly I think some of the consumer durable companies have been facing challenges around demonetisation and I think those challenges could still continue for maybe a quarter or so. However, I think if one takes a two year perspective, I think let us look at what is really happening. I think the rural economy, the worst is behind the rural economy post the India’s agriculture sector coming out of two successive draughts, deficient monsoons. We had a good monsoon last year and if the monsoon continues to be good, that becomes an interesting area; number one. Number two, we have to keep in mind that we are going to have elections in 2017 and 2018 for several states and 2019 is the general election. I would not be surprised if there is some bit of populism which steps in from the government over the next couple of years especially in the agriculture and pharma sector. The MSP, this current government has basically in its manifesto said that we increase MSPs by 50 percent. I think they already hiked MSPs by about 20-22 percent over the last 2.5-3 years and probably there is room to hike MSP by another 25 percent over the course of next two years. So, if you do really look at it, I think rural economy should be on a very strong wicket and within that discretionary rural consumption spend I think should be in a sweet spot over the next couple of years. So, I think when you see some really bad numbers for the month of February or March, or if the March quarter does not do too well, I think that should really be looked up on as opportunity to buy into some of these discretionary consumer spends especially from those companies which are focused the rural economy.