Demonetisation: Organised business to gain bigger market share: Dipen Sheth

Despite the lower tax rates there will be fiscal buoyancy as once more people start paying taxes, even with low tax, on an aggregate level there will be more revenue for higher infrastructure and social expenditure, he added.Below is the transcript of Dipen Sheth’s interview to Latha Venkatesh and Sonia Shenoy on CNBC-TV18.Sonia: Looks like everyone is in festive mood but the markets.A: Yes, it is not a very exciting festive season.Sonia: Yes, a lot of caution, but do you think that could extend into the first part of 2017?A: If you will allow me the luxury of getting a little philosophical, every once in a while, we get jittery about whether that long-term trajectory and ache din and all that is going to play out in India and we are about 10 percent off the last peaks that I can think of, somewhere there, which means the average midcap is down maybe 20 percent. Some of the largecaps have gone nowhere. Much of the largecap universe is also down maybe between 10 and 15 percent from those peaks, sometimes even 20 percent. So, this is the way this country has moved. This is the way stock markets move.Let us remain philosophical here. You will take two steps forward, one step back. There will be a little bit of a shocker here and there. So, sometimes it is goods and services tax (GST), sometimes it is demonetisation. Demonetisation is not a very accurate way of describing it. It is just a withdrawal of old high denomination notes. In fact, it is more like demonization now if you ask me. We are so caught up with this thing and I wish we could take those two steps forward over the next 12 months now.So, for 2017, if you ask me, this one step back sentimentally and emotionally is a huge step forward structurally and I wish we would not look at the wood for the trees or whatever you want to call it.Latha: But, is a bottom in place for the markets because we do not know how the earnings will turn out. We do not know how Trump will turn out.A: No, we know how the earnings will turn out. They will be soft this quarter at least.Latha: No, I mean the extent. So, will you wait to buy or are you a buyer already?A: This is the good thing about apparently or optically bad news in the markets. It gives you the chance to sit back and take a deep look. What most people do at times like this is that they take a very shallow look. So yes, there is Trump, there is the demonetisation shock if you will. But look at what can emerge out of all of this, especially the local policy mix as it has moved in the recent past. So, you can get better tax compliance. You will get arguably lower corruption. You will certainly, if you have higher tax compliance, you might get lower tax rates. You will still get fiscal buoyancy. Less than 3 percent or so of the population is paying taxes.So, if more people pay taxes, even with lower tax rates at an aggregate level, you will have much higher fiscal buoyancy, which means higher infra and social spend. You will have lower interest rates sustaining into the future. So, earnings yields will have to come down along with interest rates. So, price-earnings ratio (P/E) multiples will rise. You will get higher shares for the organised industry. And the problem with India -- despite it being a USD 2 trillion economy or something versus the more advanced economies -- is that we have still a significantly high share for the unorganised sector in many spheres of life. So, the higher share for organised players as compliance with tax laws and operating laws in the country improves.So, small ticket lending for example, we are punishing the non-banking finance companies (NBFCs) right now, we are punishing retail banks right now, but look at the opportunity. There is still half or maybe 40 odd percent of the credit in up-country areas are still done by the unorganised sector. Look at the space like batteries where 40 percent of the replacement market is unorganised. Auto ancillaries, again in the replacement market, a large part is unorganised. Appliances, real estate, exchanges, look at the dabba trading going away and what it can do to MCX. So, we are in the throws of an evolution, which is truly going to take us in line with what the size of economy that we are. We are still a bullock cart economy despite our size and that is going to change. I think this is a tremendous reason to be bullish.Latha: So, what are you buying? Are you buying the NBFCs already? Which ones?A: You have to get choosy and you have to look for NBFCs, which have pricing power, NBFCs which do have a very strong tilt towards loans against property (LAP) where the loan-to-values (LTVs) have risen because the underlying value of the real estate that you were taking as a backstop for your loan has come down and so, you feel a little more jittery.So, despite that, we remain very constructive on Cholamandalam Investment and Finance Company for example. So, about a third of their book is LAP and it does not matter in the longer run. Yes, they will go through a little bit of a rough ride perhaps in the short-term, especially in perception, not even in real terms. But look at the opportunity that will open up for them on two thirds of their business, which is up-country lending, mostly to vehicle owners, but a whole lot of other people also.People have punished DCB Bank from recent highs because of the sharp tilt towards LAP. I do not think it is blindly applicable to them. LIC Housing Finance does not even have a LAP book worth talking about. Five percent or whatever you want to call it. So, there are some great businesses out there and if you take a deep view on them right now, the 10, 15, 20 and even 30 percent cracks from the top are offering you superb opportunities to enter. Yes, Q3 numbers will be bad. You can lose another 5-10 percent.Sonia: I wanted to talk about those opportunities in the pharmaceutical space. I know it has nothing to do with demonetisation, but what is happening with Trump and the comments he is making is spooking the pharmaceutical sector. But within that, you like names like Lupin, Aurobindo Pharma, etc. You do not see any near-term pain for any of these companies?A: Like I was saying, let us zoom out and take a look here. There is a USD 350 billion drug selling pharmaceutical opportunity in the US. The market is roughly that big. I think about USD 200-250 billion is still to genericised and the patent cliff, as it were, is already upon us. So, which are the companies that you will look at? We will come to Trump in a minute, but the companies with the fat filing pipes and there has been such a lot of noise on the regulatory headwinds here. You name it and they have been raided, so to say by the US Food and Drug Administration (FDA), so whether it is 483s, warning letters, import alerts, you name it, it is all happening there. But the thing is, look at the longer-term capability that these guys have and can they put it in place, that is the call you need to take.So, 140 plus items in the filing pipe for a Lupin and Aurobindo for example. Lupin is available today for under 18x for something like a 25 percent return ratio. 25 percent return on equities (ROE) for under 18x. Aurobindo 13x for more than 25 percent ROE. If you do not find it cheap at this price, then where will you find it cheap? Alkem Laboratories is building out aggressively its US business. I suspect it is where Torrent Pharmaceuticals used to be a few years ago in terms of the relative ramp up in the US with respect to its otherwise great Indian business as well. So Alkem is there about 19x or so.If you are worried about Trump and what he will do to pharmaceutical imports into the US, then look at what is the official pronouncement so far. He is a terrible opponent of Obamacare, which seeks to increase insurance coverage. I do not know how the attack on Obamacare is related with the reluctance of the US market to accept generic imports. In fact, it is going to have the exactly opposite impact. There is no way that a US company within the US can supply generic drugs at the kind of prices that companies like Israel and India can provide. So, where is the hassle? Okay, so there will be a little bit of political noise around imports and protecting jobs and even that, for example in the IT space, there is more noise than fact there.Sonia: I was coming to that. You hold the same argument for IT companies and hence, you would buy some of them? Infosys has already risen 10 percent from its lows.A: You do not buy Infosys for a 5-10 percent gain in any case. Let us also keep in mind that Infosys is down over 20 percent from its recent peaks. So, the thing is that Indian IT is going through a very interesting phase. The entire sector has got challenged at a global level by the evolution that is threatening to take away IT jobs. I am never of tired of saying this. What IT has done to other industries in terms of kicking up their productivity and eliminating jobs there, is likely to play out in the IT space itself in the next few years, this entire digital shift, which is going to play out.A lot of Indian companies -- we are getting jittery on them in the markets about whether their old growth rates cans sustain. Now, consider for a minute that the large Indian IT companies are now at a base of about USD 35-40 billion run-rate. For them to grow at 20 percent at this base is a steep ask even in normal circumstances and in these changing and evolutionary circumstances, the USD 3.5-4 billion of aggregate revenue add that we will see every year translates to somewhere between 7 and 10 percent. I do not think that is a bad deal, first.Second, some of them are reinventing themselves whether it is Infosys in terms of the internal management rejig that has happened, whether the tilt of HCL Tech towards the infrastructure management services (IMS) business goes. In the midcap space, you have clearly differentiated offerings like Persistent Systems or a Zensar Technologies where growth visibility is much higher for these companies than the rest of the midcap space. So, for example, we have downgraded Mindtree when the lack of growth visibility was beginning to hurt. So, it is a mixed story out there.Latha: Since you are so bullish on demonetisation, are you not playing any of these digital themes? Have you discovered any stock?A: I must confess. The direct play that is visible from demonetisation, many of the e-wallet companies and so on are still venture funded and unlisted, so you cannot play those. But the private banks for example, offer tremendous opportunity. This is only one of the many reasons why you should be constructive on the large private banks. I do not think this by itself is a very large lever for you to buy into the private banks.On the other hand, the business like exchanges, the minute the 'cash ki leni-deni' goes out of the system, look at the amount of dabba trading that can come on to the organised space. So, all that shift from unorganised to organised players. So, batteries, auto ancillaries, exchanges, appliances, all these spaces -- and you will see a crack in appliances' revenue growth. In fact, you might even see a degrowth year on year for some of these guys, the small appliance guys. But that is all the more reason to get constructive on them. Maybe these are just crouching tigers before they are about to leap.