Midcaps still in reckoning; like Lupin, Axis Bank: HDFC Sec

Midcap index has been up 23 percent since start of the financial year and there continues to be opportunities there, says Dipen Sheth of HDFC Securities.“Different themes are playing out for different midcaps,” he adds. Speaking to CNBC-TV18, Sheth says that the pharmaceutical sector has gone nowhere since the dream rally in 2014. There, however, exists potential. He is positive on Lupin and is expecting a 20 percent compounded annual growth (CAGR) over next 2-3 years on back of strong US pipeline and strong management.IT sector, which has been under pressure, has value over a long period of 1-3 years. Coming 1-2 quarters will continue to be painful for the industry. Among private banks, Sheth is bullish on Axis Bank. The stock has been battered already and the bad news over asset quality is nearly done. Sheth is also positive on M&M over expectation of strong tractor sales. Below is the transcript of Dipen Sheth’s interview to Sonia Shenoy, Latha Venkatesh and Anuj Singhal on CNBC-TV18.Sonia: Before I ask you about the markets, I wanted to ask you about the stock of the moment which is Lupin. It is up almost 7.5 percent on the back of that Goa facility getting the US Food and Drug Administration (FDA) clearance. This is one stock that you have been bullish on for a while. The stock has lost a lot of its value over the last 3-6 months. Think this is a good time to buy?A: Not just Lupin, the entire pharmaceutical sector after a dream run over much of 2014 and some of 2015 has actually gone nowhere. It is a highly capable sector and the latest noises from the Department of Justice are only adding grist to the mill. Look at what has happened to Sun Pharmaceuticals for example or Taro Pharmaceuticals within Sun Pharma, the kind of inquiries that might come up and with the US elections coming up and the nationalistic noises, so to say, made by Trump. So, it all adds up to bad vibes and tidings for the pharmaceuticals sector. Interestingly, Lupin is not even named in that inquiry so far. So, to batter the entire sector, even Lupin fell the last Friday I believe when this news came out. So, it has got one of the best US launch pipelines, a huge existing US business, one of the few branded players in its slice of generics in the US, very capable promoters sharply focused next generation now taking charge. Mid-teen multiples with this kind of capability and this kind of growth rate, we are expecting at least 20 percent compounded annual growth rate (CAGR) over the next two or three years.I do not think there was any doubt in our minds on Friday that Lupin was being punished unnecessarily. It is not just a 6-7 percent trade what has played out today, it is much more than that. Yes, if Trump wins, let us say, you might see a risk off and you will get all these stocks cheap again, but you really do not live for those moments. The smart investors have bought Lupin today.Latha: Let us get back to the big sector of the markets, the financials. We saw those decent numbers, decent as in the rot seems to have been stemmed in Punjab National Bank (PNB) and we were just reading out Hindustan Construction Company (HCC), the asst issue has been resolved, so to speak, so some unsustainable debt has been knocked off or converted into preference shares. The point is some recovery is happening. I know your preference has been for private sector banks, but will you look at any of the public sector banks now?A: This thing about being value buys, the large reckless borrowers in the private sectors now coming round to getting their dues from the government or restructuring their assets. You saw what has happened at Essar, you are seeing the kind of curing that can happen at HCC and all this is inter-linked. And this all now lands sharply into the lap of the government in the sense that this is the last sticky, big hairy reform, if you can call it that which they are still struggling with. To our mind, there is a lot many miles to cover from here. There is rhetoric, there is some action, but it is not quite adding up to much. So, headline slippages for both PNB and Union Bank over the weekend have been close to 5-6 percent, not to mention their restructured books, their scheme for sustainable structuring of stressed assets (S4A) and whatever else, all kinds of other stress that is there on their books, special mention accounts (SMA-2) and all that. So, if you add up all of that for PNB, we are looking at close to nothing left on net worth. So, if you add up all the stress on their books and you look at their capital adequacy, it is enough to wipe it out. Now does it mean that PNB is broke as a bank? Of course, not. But does it mean that there is a huge challenge in front of the government to mend this entire enforcement of lending and being able to repossess assets? If the government gets over this, we are in for a decade of super normal growth and there is no other country in the world which is positioned like this.Anuj: IT stocks, what do you do here? You have, on one hand Infosys and other frontline stocks at 52-week lows, but you are finding stocks like Cyient, NIIT Technologies in the midcap basket which are doing phenomenally well.A: Just look at the index. I was just noting this down before I came here. The IT index is down 12 percent since the turn of the financial year. Compare this with the Nifty Bank index which is up some 18 percent, the midcap index, which is 23 percent, those two guys are on fire. And I was just complaining about stressed assets in the system. So, there is a reason why the Nifty Bank index is up that way and it is driven by the banks which have performed. As simple as that.In so far as IT goes, the nationalist rhetoric from the Trump camp about discouraging off-shoring or H-1Bs and all that, we see this around every US election. This time, the fear is a little more than artificial, because if this guy comes in then there will probably be a little bit of rapping on the knuckles. But to my mind, the United States remains a doggedly capitalistic economy and anything that helps them save cost for the economy, even if it damages some of their businessmen, and only at the margin by the way, is going to be accepted over the longer term. And we will see that happen in pharmaceuticals and IT. You have frontline IT stocks now available for well under 15x. You have midcap IT stocks now available for 10x-12x or something. And these are great businesses.So, I would certainly look for value in IT. Maybe there is another quarter or so of pain, especially around the election announcement, but for a 1-3 year investor, there is a lot of value on the table.Latha: Which part of the financials are you buying?A: It is easy to classify the private sector banks as being far too costly right now. Most of them are 2.5x to even 4x and so on for some of the larger banks. But at the same time, you have ICICI Bank and Axis Bank which are much cheaper. And there is a reason for that because in their own ways, they have replicated the pain that is played out in the PSU space. There is some early evidence of healing available in ICICI Bank and today, they are going to declare numbers. I do not think there will be anything less than a Rs 10,000 crore slippage if you ask me. But anything significantly less than that and utilisation of headroom that they will get from the potential life insurance stake sale to make extra provisions this quarter will only help heal their books further. But like I said, there is a lot more ground to cover. In the case of Axis, I believe that much of the bad news has been factored in. The stock has got battered, the only significant overhang for Axis is the Specified Undertaking of Unit Trust of India (SUUTI) stake sale and that is of a technical nature. All the bad news which were waiting for so long has already been reported by them. It will continue to be bad for a while, but that is also known to the market. So, I suspect that there could be a value buying opportunity emerging maybe about Rs 450-470 or thereabouts at Axis.Sonia: One more sector that has done phenomenally well this quarter is tractors and within that, Mahindra and Mahindra (M&M) is the stock that you like. It has not really performed much over the last 6-12 months, but you think now is the time?A: Yes, because if I remember right, volumes are up some 36-37 percent or something. You have to look at rural India as coming off two bad monsoons, clearly now with rising urbanisation and the services sector taking off, a sustainable and structural labour shortage playing out in the rural interiors. Cost of finance coming down, monsoons looking good and what will farmers want to do? They will want to invest in tractors after two years of lying low. This is a highly cyclical industry, farmers react immediately to price movements in crops, they react immediately to monsoon prospects, they react almost immediately to falling interest rates and so on. This is a reason why we are constructive on M&M, no doubt about that. They have interesting launch pipeline also in SUVs, but that business is under challenge from a variety of sources, no doubt about that. Their tractors business is, of course, a very high return on capital employed (ROCE) business and once that gets into the operating leverage mode, it will be spewing out cash like nobody’s business. I suspect M&M is a clear value buy, if you believe that the next two monsoons are going to be good. The crib that I will make about this company is the way it allocates capital across a whole lot of its subsidiaries. Some of them of course have created value, but the jury is out on some of them.Anuj: The stock that has corrected quite a bit is Asian Paints. Even as we speak, it is one of the top index losers. Ever since its numbers, it is now down 16 percent. Do you have coverage on this?A: Asian Paints, the business is fantastic. I do not think the business will go anywhere near being bad for the next two, five or maybe even 10 years. We have seen Berger Paints India replicate some of that success at its own size, a smallcap like Shalimar Paints coming up the curb and so on. The valuations is what is wrong with Asian Paints and anything north of 40x-45x does not make you feel comfortable. After all, how much volume growth and how much earnings growth can you do? They were gaining this huge advantage because of falling oil prices and gaining in gross margins and they did not really have to invest in marketing and distributing to that extent. Of course, it is a company that continuously keeps doing that bit, but the one time advantage that they got from falling oil prices and oil going down from USD 102 per barrel to maybe sub-USD 50 per barrel. So, that big trade in their gross margins has certainly played out. I think it is a great business, but to make money on the stock is tough here on.Latha: Will you still back midcaps over largecaps over the next 12 months?A: That is a very interesting question because like I said, the midcap index is up 23 percent since the beginning of the year, so definitely, there is some froth there. But there are some very solid stories. During this Diwali session, we identified some 15-16 odd midcaps and the midcap sector always is going to be less about broad based stock picking or looking at macros, and looking at micros actually. So, you have different themes playing out for midcaps and we have a dime a dozen names I can tell you about at more than 2x price to book. City Union, close to 2.5x looks very good, for example if you look at the financial space. Now you will look at guys like PNB at 1x and crib that why should I buy such a small bank. So, there is capability that gets paid for and some of these guys will go to 3x and 3.5x in a bit. So, I do not know where to start looking for when you ask me a generalised question in midcaps. I can rattle off a whole list of stocks, but there you are. The sense that I am getting is that many of the high networth individuals (HNI) and smart investors have taken some money off the table right now because of this big risk off that might happen with the US elections.