Quality companies with low debt would shine in the medium term and this is the time to be discriminating and pick them up, instead of worrying about a Nifty collapse, R Venkataraman, MD, IIFL Securities, said in an interview with Moneycontrol’s Kshitij Anand.
Q) The US Fed plans to keep interest rates low for a long time. What is the kind of impact it will have on emerging markets like India as well as the currency?
A) India has already seen strong FII flows (~US$11.5bn during May-Aug 2020) and the RBI so far was actively buying the dollars to maintain a competitive exchange rate.
However, the RBI struggling with managing multiple objectives (the competitive exchange rate and lower inflation levels) has recently hinted that it would let the currency appreciate as buying dollars is adding to rupee liquidity in the system and strengthening the rupee is slightly positive for inflation (A RBI study concludes that 5% change in INR-USD rate leads to 20bps change in inflation).
That said, equity market flows will also depend on corporate profitability and growth expectations. Our analysis shows that FII allocation to India (relative to peer EMs) actually fell in the last five years and one possible factor could be the narrowing profitability gap between EM and Indian corporates.
Q) It looks like it is raining IPOs, especially in the month of September. What is driving the momentum?
A) Momentum in secondary markets tends to push primary market activity also. Further, the corporates have been focusing on strengthening the balance sheet to survive the lockdown phase and some of the primary market activity is driven by this effort also.
But, as of now, we are unsure if old economy companies can as easily raise capital. The IPO momentum is very recent. Big companies usually raise funds through QIPs rather than IPOs.
Q) Market seems to be walking on a tight rope as geopolitical concerns as well as COVID-19 cases are not coming down, but yes there is some hope of a vaccine but that too is still some months away. Are we nearing the peak – we could have a touch and go moment with 12K and then fall?
A) While there is a significant influence of lower interest rates globally and in India, but today risk premia also seem to have sharply collapsed. The recent rally from 9.5k onwards on Nifty has seen a significant broad-basing of PE re-ratings.
In a recent study we did, we found that virtually every sector had re-rated in the last year on normalized forward earnings.
Normally, we would worry that fundamentals being poor would imply that Nifty would retreat, but today we would say that quality companies with low debt would shine in the medium term and this is the time to be discriminating and pick them up, instead of worrying about a Nifty collapse.
Q) Do you think the smart money or has it already started rotating towards quality small & midcaps? Any stocks that are on your radar?
A) The recent SEBI circular on multi-cap funds has raised hopes of a sustained rally in mid and small-cap stocks. However, since the mutual funds have several options (This is acknowledged by the SEBI clarification circular also), the much expected multi-cap portfolio re-balancing may not happen at the currently anticipated scale.
That said, companies like Ashok Leyland, Kaveri Seeds, Deepak Nitrite, Sudarshan Chemical, etc. have strong fundamentals and could benefit disproportionately if the MFs were to reallocate funds to mid and small-cap stocks.
Also, as seen recently, small-caps can rally rapidly on small volumes and while that may sustain, it is unlikely that any meaningful proportion of money rotates out of large caps, as they represent 75 percent of overall m-cap and at best a small proportion may switch towards mid and small caps.
We like select chemical names (Deepak Nitrite, Aarti Industries, Sudarshan Chemicals), pharma (IPCA, JB Chemicals), auto, and related names (Leyland, Kansai, Apollo).
We would look at Zee Entertainment too, being a unique name being a Nifty stock and midcap, and a company where there can be significant rerating.
Q) So we keep on talking about quality small & midcaps. How do you define quality?
A) We measure quality as follows: a) strong corporate governance, b) Profitability should exceed the cost of equity, c) visibility of strong growth d) a good track record of capital allocation e) strong corporate governance f) acceptable leverage.
Q) Warren Buffett, the man who pioneered buy and hold investing, just made quite a fast billion bucks from a type of investment he once mocked. It looks like value investing is also changing with time and Warren Buffett is leading it even at the age of 90. What are your views?
A) Value investing seems to be generally wrongly understood as buying single-digit PE stocks. Low-interest rates will put paid to that before long, with the exception of state-owned strugglers.
Buffett always favoured good businesses at attractive buying opportunities, but with liquidity being very generous globally, and price discovery being quicker in a quantitative age, such undervaluation does not last for long.
Hence, good businesses will generally be somewhat pricey. Even here, given a deteriorating economy, the range of businesses that can be considered investible may narrow over time, and everyone including value investors may face this limitation and lose differentiation, one more reason to not take these monikers too seriously.
But, if growth revives, then this debate may be more worthwhile since investible choices will widen.Disclaimer
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