The ongoing Brexit scare could lead to opportunities for the bottom-up investors.
Even as the shadow of a possible Britain exit looms large on global financial markets, a scare could likely engulf equities in the near term.
"But this would lead to opportunities [for bottom-up stock pickers] as well," says Dipen Sheth, Head of Institutional Equities at HDFC Securities.
In an interview with CNBC-TV18, he picked Jubilant FoodWorks ("we are shooting for doubling of profit growth in two years"), City Union Bank ("it has a strong lending franchise in Tamil Nadu") and V-Guard Industries ("a very strong brand that has helped it expand on an asset-light model") as stocks that could compound well going forward.
Below is the verbatim transcript of Dipen Sheth's interview with Latha Venkatesh and Sonia Shenoy on CNBC-TV18.
Sonia: Would you be worried at all or do you think this is a great opportunity in adversity?
A: I am worried but it is going to lead up to an opportunity. I am worried because the world is still grappling with a host of problems not least of them Brexit, the European Union is being called in to question as it were with Brexit looming as a scary possibility.
I might sound funny to say this but we have a similar situation of diverse cultures, languages and all of that and we have been holding together the Indian union for much longer with arguably more inspiring results for now at least. Here is a very prosperous part of the world at an aggregate level as because the United States is a little larger if I am not mistaken, in economic terms at least. And they are grappling with how to free up the flow of trade, labour and how to achieve monetary union on the way to a political union and they can't seem to get it right and with such a large player like Britain threatening to exit.
There is a lot more which is going to come not just in terms of the Brexit event itself but what this might lead on to for the EU and for the rest of the world. There is going to be a scare - there is already a scare and if that scare leads to outflows from emerging markets I wouldn't be surprised at all.
I would add to that, it should lead on to a great opportunity to buy into this messy country, which is less messy than the EU than the current form at least.
Latha: Where would you look for value? In your list first up is Jubilant FoodWorks. If you pull up one year of that chart, it has fallen a lot. So, is that what is making it attractive?
A: No, pull out the five year chart and you will see a message there. Why I have pulled Jubilant - it is not that I am looking at what is going to happen quarter or two from now because even last quarter their same store sales growth was just a shade over two percent or something. Volumes were actually down. They took two price hikes during the year. So, that is not the thing.
The thing is that here is a franchise of world class and famous brand name which is feeding into aspiring India, which is feeding into it. So, there is this big demographic and urbanisation dividend that Jubilant directly addresses. Younger people, more cities and a 1000 outlets is nothing in a country of this size, 1000-1100 or whatever.
This company even on current form is running at high return ratios, clean cash flows. This can compound for so many more years. Why are you looking for the weather, let us look at the climate. We are shooting for a doubling of profits in two years. Currently the stock looks tired.
So, you look at valuations it is more than 31 times on FY18 basis at the current price. Our target price is Rs 1,342 from a one year perspective, but with a 1000 outlets you can be a 2000 outlets over the next 6-7 years. They are opening about 140-150 outlets every year. What if urban consumption revives, what if consumer sentiment improves, which it will I suppose given the demographics and urbanisation.
Sonia: But for them the problem is very inherent. It is the kind of rentals that they pay, the kind of their cost efficiencies are lower.
A: They are at 12-13 percent margins now from the 16-18 that they would like.
Latha: There is now serious competition from Swiggy, which is delivering food at home. Until now Dominos was the only food that came home, now there are multiple options. So, are you still confident of the doubling?
A: Yes. Competition expands awareness, competition pulls people into the food chain as it were and people would upgrade to Dominos faster than they would otherwise. There is a variety of lenses that you can look at this company through. The lens that appeals most to me is that they are just getting started on the opportunity. There is multiple years of compounding possible here. So, 30x is not a bad number to pay.
On the 12-13 percent margin bit, I can tell you that gross margins are extremely high in this business. So, look at the scope for operating leverage. If same store sales growth picks up to 5-10 percent -- the good old numbers that we saw in FY10-FY11 -- can you imagine where this stock would go when business performs well?
Latha: At home Dominos was the only pizza that we will order. Now we are able to order other foods because of Swiggy.com.
A: Look at the number of new Lathas that are coming up to order from Dominos.
Sonia: As opposed to the e-commerce business model do you see margins contracting further?
A: No, I don't because pricing power is still intact. Operating leverage will drive up margins if anything. We are seeing a bottoming out of margins here and the point is when the current trajectory of margins is downwards.
So, the lazy analyst is going to project this forward and say this is where the margins are going to go. But you look at the construct on the margin, if you model this company well enough you look at the sensitivity of margins to higher volumes it is crazy.
Latha: How about City Union Bank. Why that case for City Union and why not for say, Federal Bank or DCB or Equitas varieties?
A: It doesn't mean that just because I write City Union today, it is not that I don't like Federal Bank. Of course, there are asset quality issues there which they (Federal) should be getting over hopefully in a bit. It is obviously much cheaper than City Union. It is not that we don't like Equitas. We are in the process of rolling out coverage there. We are very constructive on both the new listings in the SFB space. I hate to call them microfinance companies any more. So, it is not that we don't like the other names -- DCB, for example, is an excellent small business franchise.
Like Jubilant, the good thing about City Union Bank is the fact that it has in the banking space this is one of those instances where it has very strong franchise and remember I work for a subsidiary of a bank which works in the same geography. So, our bank works across the country and the sense we get internally as well is that this is a bank whose lending franchise is very difficult to crack.
They have been lending for generations to small businesses in and around Tamil Nadu and some of the south but not as strongly as they are in Tamil Nadu and they are very difficult to dislodge. So, when you look at their headline current-account-savings-account (CASA) ratios, you don't feel too inspired but their spreads are still fat because they are able to lend to the same blokes -- small businessmen -- who would otherwise be eligible for borrowing at lower rates from other banks but they refuse to budge.
To my mind, that is a franchise which is well worth paying a premium for. The last two or three years have seen them expanding footprint and adding costs. This was accompanied by a slip in asset quality and all three factors are now going to reverse when they expand, they will get operating leverage, their asset quality improves. So, their provisioning costs come down. To my mind 1.8x for a 1.5 percent Return on assets (RoA) bank is not a bad price to pay.
Sonia: You have picked up V-Guard. That stock has gone from Rs 800 to Rs 1,300 since the month of March. What kind of value do you find there?
A: Just because it has run up doesn't mean it can't run up more. And just because it has run up in the last 3-6 months doesn't mean it will have to run in the next six months either. So we could see a little bit of breather here. I am not against that but I will tell you what appeals to me in the V-Guard business.
That is that here is a very strong brand franchise. Like Jubilant, like City Union and so on in its own little space it is a very strong franchise, very strong brand and the goodness of that brand that connect with consumers happen because of a very reliable range of voltage stabilisers that is how they started off, by being well known.
Now, voltage stabilisers is just a part of their business right now, I won't say it is a very small part or something but the point is they have used that brand name to build out the rest of their appliances business. So, whether it is fans, whether it is wires, other appliances, geysers, water heaters and so on, and they are doing this with an asset light model which means most of the manufacturing barring one or two items like wires and so much of it is farmed out. So, their asset turns out high, their return ratios are high.
They are right now in the throes of expanding their footprint and it has been happening for a while now across the country from a very dominant position fro down south. So you have category expansion, you have geographic and reach expansion. So, they have sustainable and steady state margins if I can say so could be much higher than where they are and this continues to be something like a 30 percent kind of return ratios business. So, why should I not pay a high multiple for this.
It is still 22x and I don't think that is costly at all. When you are paying 35x and 38x for stuff like Asian Paints -- which has a brand name and of course Asian Paints is a much larger company -- but look at the under penetration of the organised brands in the appliance space. Look at what can happen in the small appliance space as India urbanises and look at the opportunity here.
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