Dipen Sheth outlines three investment themes worth chasing

The change in central government, expected fall in interest rates along with global developments such as crude price slump has given rise to investing themes that investors should closely study, says Dipen Sheth, Head of Institutional Research, HDFC Securities.In an interview with CNBC-TV18's Latha Venkatesh and Sonia Shenoy, Sheth said recent government steps to carry out reforms in the banking space would help public sector bank stocks such as SBI and Bank of Baroda.He is also positive on the commodity consumer theme space, maintaining that the full benefit of, for instance, the fall in oil prices is yet to reflect for companies that use crude derivatives as primary raw material (such as paints and lubricant companies).Finally, he also said investors should look at what he considers 'long bond' stocks -- or stocks that benefit from falling interest rates much like bonds."Companies such as Bharti Infratel and Power Grid are poised to see growth from specific events (such as 4G rollout and greater capex and commissioning, respectively)," Sheth said. "As the risk-free discount rate comes off, such companies will have warrant higher valuations going forward."Below is the transcript of the interview on CNBC-TV18.Latha: For the longest time, the Nifty has been between that 8,300 and 8,600 mark. Is it that we have to follow the market’s cues and look at the midcaps, not at the heavies at all?A: The last time I was here, I told you we are kind of stuck in a range. For a change what I am saying is actually working out. So, I do believe we are stuck in some kind of range, but the beauty about being stuck in a range from an investors perspective is that it gives you a lot of time to think, think through, identify medium or even, I dare say, long-term themes. Pick your stocks and wait patiently, instead of - the old adage in the markets was invest first and then investigate. That is the way you chase momentum. You do not really have to do that which means you are not really running the risk of doing silly things. A lot of the changes, the big violent changes that were supposed to, which have played out over the last year, ever since the government change happened and all that, all those big fluctuations have played out. Now, this is the time to do deep down study and take a considered view. And this market is actually giving an opportunity for you to do that. I am not complaining.Sonia: You opened a savings bank account in six minutes, where did you do that and how are you positioned on the PSU banks now?A: One of the themes that will play out aggressively for investors, for economies, for countries and for society at large over the next few years is dramatic shifts in technology. We keep hearing all these grandiose articles and columns about how technology is going to change everything. I have heard this about technology for closed to two decades now. Much of that has actually played out. However, I think we are at yet another cusp of break through changes and technology because this time technology is not just enabling better operations or breakthrough product designs or more efficiency or so on. Technology is now helping us delivery things to people and to mass delivery services and products to people in ways that were unimaginable even a few years ago. So, this morning while I was having my morning cup I downloaded an app from bank which allowed me to open what they called a selfie account. It sounds very teenagerish. Latha: But how to they do a know your customer (KYC)?A: That is the beauty. I am not sure whether the account is technically open right now or not, but I do have an account number. I took my picture which is where the selfie account branding comes from. I took a picture of my IT pan card and a picture of my Aadhaar card and they even have optical character recognition. So, they picked up everything from there and they actually put it into the form and they said, “Okay, press 2, you are done.” And I too six minutes, because I wasted three attempts at taking my own picture because of the lighting and... (interrupted)Sonia: So, which bank is this?A: And here is the surprise. So, it is what I always used to think was a half dowdy bank, I would not say, as dowdy as the public sectors (PSU) in many matters related to customer service. Again, not to take anything away from the PSUs on the virtuous cycle of their businesses. So, this is Federal Bank. And I was completely amazed. For me, Federal Bank was an old generation private sector bank with so many of its branches in Kerala... (Interrupted)Sonia: Federal Bank has been a buy for you for a while, right?A: Of course. So, there are a lot of good things that have happened at Federal Bank over the last few years. For me, their caution at being reckless with lending. At a time, they were well-capitalised, they are still very well-capitalised, stood them in good stead and the minute they started noticing a little bit of pain on their corporate book, they held that back very tightly. They have got a very good retail and small and medium enterprise (SME) book. And from time to time, they come out with small negative surprises on asset quality or one or the other thing and people are kind of getting impatient about them. But I think, to me, a bank like this, offering me a service like this is not just symbolic on Federal Bank changing character, which is of course a theme that is playing out over a period of time, but the entire banking sector, that if an old generation an allegedly old generation private sector bank has got this thing going and the app works like a dream, then there is a lot to be said for how technology can transform our financial life.Latha: Yesterday, State Bank of India (SBI) opened its mobile wallet.A: And, yes, so, SBI Buddy. Now, I will try out SBI Buddy and I will equally, vociferously praise it if I find it good enough. But, it is not my praise that is going to do the wonders for SBI Buddy, I am sure. It is what the user experience across millions of users is going to be like.Latha: What is in your bank buy list?A: State Bank of India (SBI) is there but not because of Buddy alone or not even because of Buddy. We have a buy on SBI since I don’t know when. Like Federal Bank from time to time, it gives us nasty surprises. More than nastier than Federal Bank I must say on asset quality but some of that will change. Maybe we have seen the worst of asset quality and may be this government will get its act right in terms of solving its non-performing assets (NPA) problem. Now that they have figured out puting in capital in PSU banks, empowering them with chiefs who come in from private sector or even professional appointed chieftains, 10 percent of the work is done maybe 90 is still left.Latha: We do go below SBI into other PSU banks.A: You don’t have to go much below SBI to discover Bank of Baroda (BoB). Latha: So both are your buys?A: Absolutely.Latha: Even after the recent 15 percent jump in BoB shares, you are still comfortable?A: Traders will probably book profits now I guess. It is not the price level that I am talking about right now structurally if the government takes forward the good work that it has done late last week and figures out a way to tackle this elephant in the room which is the NPA thing and stressed assets levels running at well in excess of ten percent for many PSU banks. If you figure out a way of setting up the legal structure the terms of engagement for PSU banks to be able o chase errant lenders, to be able to be able to recover money that is stuck. To be able to en-cash bank guarantee, to be able to seize collateral, to be able to run down equity for errant promoters who are misbehaving or who have gold plated projects. Can this government do it? I am getting increasing skeptical I must confess but if this government can’t then which one will?Sonia: So, that is one theme that you have spoken about, the banks the other theme that you have been bullish on is the low commodity prices, the beneficiaries, so, some of these paints and branded lubricant companies. Which are the stocks that top your list and do you think that the benefits have not been priced in already?A: It is not a question of benefits getting priced in because you will see headline multiples running well in excess of 30-33x or something for Asian Paints on one year out numbers, and maybe slightly lower for Pidilite. And maybe about 20x or something -- I do not remember the math for Gulf Oil Lubricants and so on. But look at these guys. They have 70-80 percent of their raw material mix coming in from crude derivatives. Crude is down from a USD 100 plus to under USD 50 or wherever we are now. It is only a matter of time before this begins to reflect in base oil prices, let us say, or in Phthalic Anhydride prices for Asian paints, titanium dioxide is down and so on and so forth. And volume growth is certainly not going to be challenged. Pricing power with 54 percent market share, dominant position, no other player willing to cut prices desperately, nobody pretending to be loss leader, like, let us say, in telecom. So, these are stocks to own for a number of years from here on.Latha: Let me come to your - what you call long bond stocks – the safe bets Bharti Infratel and Power Grid you think they will never lose your capital? A: First of all why do I call them long bonds stocks so they are like these guys are sitting on fat assets which just delivery cash year after year at very high EBITDA margins. In case of Power Grid it is actually 95 percent or 97 percent or some such number. Now that is nothing to get excited about because the asset returns that they get are very low also but that is not the main thing. The main thing here is that there is nothing in the business models of these companies and for different reasons that threatens these cash flows from growing in a very predictable way over time. So, let us say in Bharti Infratel’s case it is the simple thing of 4G roll out. It is the simple thing of more and more towers getting populated rather towers getting populated with more and more tenants. So as tenancy rises in a tower there is disproportionately extra cash flow that is generated from a tower. As those cash flows build up over a period of time and the rate at which you will discount them is a function of what the risk free interest rate is in the economy. As interest rates fall, which is my big thesis or which has been everybody's big thesis for the last year or so -- and it is kind of push back a little bit right now but it doesn’t really matter. So as interest rates fall net present value (NPVs) of a stock like Bharti Infratel should rise. Infratel has more than doubled in the last year and a half or two, I am not sure. You will have to pull out the number or graph of that.On the other hand in Power Grid here is a company which is – so there are two reasons to like Power Grid. One is that their capex and their commissioning is going to get better and better for the next the three or four years from here on. As their commissioning improves the net profits which will be allowed to their mandated rate of return 14.5 or 15.5 whatever it is so this is going to give them larger and larger cash profits in the business which will again be re-deployed at the same rate. So, I am willing to pay a hefty price to premium for it way beyond the 1.5 headline number that you might see.