NBFCs rally ahead of fundamentals, book profits: Madhusudan Kela

Commenting on the non-banking financial company (NBFC) space he recommends profit booking as some stocks in this sector are trading at 5-6 times PE.

He feels that some NBFC stocks have rallied much ahead of fundamentals.

On the consumption space he advises investors to keep a bottom-up approach.  

Below is the verbatim transcript of Madhusudan Kela’s interview to Anuj Singhal, Sonia Shenoy & Latha Venkatesh.

Anuj: First your thoughts on this historic moment that we had yesterday, on Goods and Services Tax (GST). It is not of course done deal yet; it is still going to take time. But do you think ingredients are in place for this to be a big cue for the market?

A: Let us celebrate this day. To me it looks like really a done deal now. It is only a matter of formality because it was a historic vote in Rajya Sabha. We have never seen this kind of voting, 197 to 0. So, that speaks like the kind of consensus the government has been able to build on such a landmark bill. After 1991 this is the biggest reform India is seeing. Let us not count the benefit in the next three-six months but it has taken 10 years for this bill. It has been discussed. So, every minute detail has been discussed.

So, after so much 'manthan' as I would call it this has got cleared. So, I am quite hopeful that this is a landmark thing from India perspective. However, from a foreigner perspective, it will go really a long way. I was flooded with phone calls from my friends out of India, whole of last night, they were all rejoicing that finally this crucial bill is passed and the way the government has done it is very remarkable.

Latha: That is what I wanted to ask you. You must - as you said - be speaking to a lot of foreign investors. Does this bring up the India rating in a biggish way for them? After all we are a growth country. However tepid it may seem for us, they are countries with deflation and practically no growth and there we are seeing fissiparous tendencies of Brexit indicating others may also move out. Here we are indicating some co-operative federalism. Will this move us several notches up in Foreign Institutional Investors (FII) rating?

A: I think so. I don't know about the immediate thing. We will think that the GST will tantamount to a USD 10 billion incremental over the next two months - that may not be the case, but it definitely notches -- there is a larger consensus in India on the economic development on the way forward that all parties for a crucial thing can come together and can in spite of having their differences at election level - that is what the foreigners are excited about. They are excited that it will lead to a tremendous amount of ease of doing business because I come from a trading business community; I know what the pain of doing business is. It will remove corruption to a very large extent. It will improve efficiency once it is implemented.

However, what I am suggesting here is let us not count the benefit. There will be teething trouble, maybe 12-18 months because if something landmark as this gets implemented hopefully there is not going to be too much teething trouble but one should not expect that it is going to be absolutely smooth implementing this. There will be some sectors which will get hurt. There will be some sectors which will benefit, but from an India story perspective from a signal perspective and as you rightly said this is getting passed at a time when the world is struggling for growth. The incremental impact for us will be over 1 percent of gross domestic product (GDP). There are not too many countries in the world which are growing at one percent in terms of GDP.

So, in the contest where the world is and the struggle the world has for growth, it could not have come at a more opportune time and this sends an extremely strong signal to the foreigner as well as domestic investors that India is on a right track, that the government is on a right track and they will do everything which is required to put India on a growth trajectory.

Sonia: In fact we have a lot of things working in our favour now. Not just the GST but the other issues. The monsoon is playing out pretty well; you have the seventh pay commission recommendations, one rank-one pension (OROP) etc. Do you think the stage is set for our markets to hit new highs before the end of this year?

A: That is what I am saying; sometimes you should also pat our back. We are the people who shouted through the roof in most difficult times that this is a market to buy.

I would say let us also be practical that the markets have recovered quite a bit. We see some amount of euphoria but some amount of discomfort in terms of valuations in certain sectors. So, some of the positives are also built in the market. In the long run obviously India story remains pretty much intact as we have spoken for many years but maybe in the short term lot of these things - the GST is going to pass, there were near consensus, monsoon is good. This has been discussed with the market for last two months. So, in the near term I don't know how much more room the market has to go from here.

Anuj: Some pockets have signs of exuberance or overvaluation, non-banking financial company (NBFCs) for example. Do you recommend taking some profit here or do you think the growth will take care of valuations going forward?

A: Without a doubt. Wherever you think the valuations have run really ahead of the next two-three years growth and if you are a prudent investor -- someone taught me in the beginning that at the end of the day man grows old but the market never grows old. This business will continue, we will keep getting opportunities and wherever we get exuberance, wherever we get some of these NBFCs trading at five-six times book value I would strongly recommend that people who are prudent they should evaluate it is not a sector as a whole but it is some company where there is exuberance obviously profit should be taken.

Latha: In any case what is the sense you are getting about the levels now. Do you think at least the bottom for the market is protected because of these seminal reforms that we are undertaking and the expectation that the monsoons will mean better earnings in the second half?

A: The biggest thing for the market going on - let me discuss apart from what is happening in India - there is USD 12 trillion of liquidity which is at a negative interest territory. A lot of this money has gone into the bond market and this is where it is reflected that people are not keeping a 50 year Switzerland bond to earn negative yield but because people expect that bond prices can still go further down from here. So, they are playing for capital appreciation.

Our point is that if a small shift from the bond market to equity markets globally because that shift will have to happen at some point of time. I am not saying that it will happen over the next three months but whenever that shift happens that is what is clearly creating a base for the market, not only in India but globally. So, when we look at the typical metrics that we see that the valuations have got a little overheated, there is little overextension of equity markets not only in India but across world but let us not forget the floor for the market is the shift of money from the bond to the equities, not only for India but globally and when that happens - I am talking of USD 12 and USD 14 trillion being in bond a small shift can get billions of dollars in equity market and that is the missing piece for people who traditionally look at market as to how to do valuation at this juncture.

So, if we recognise this fact that at some point of time this debt money which is there and the debt bubble which is building up globally some amount of money will get shifted in equity. We can safely assume that some kind of bottom definitely is in place for our markets as well.Anuj: What is the big call from here? What stocks or what sectors do you think will take leadership. We have seen private banks do well but valuation is a problem there. IT of course valuations are supportive but growth is a problem and that is the two big sectors. Where does leadership emerge for this market to go higher?A: As we discussed even last time there is one theme which we continue to like wherein you will have to not be very sector specific but bottom up specific which is linked to consumption because in our view this seventh pay commission is a very big deal and it is going to deliver benefits to the corporate India over the next two-three years. So, whatever fall, whatever sectors or bottom up companies which fall under that consumption theme we continue to look at those companies whether they are in the travel and tourism space or whether they are into selective, into airline space, whether they are into media and entertainment space or a plethora of other sectors which get covered under this scheme. So, we continue to like bottom up stock picking on this space very clearly.Latha: I wanted to ask you about NBFCs. We saw this huge run up in Capital First and Bajaj Finance variety of stocks. But today we are getting this Dewan Housing Finance Corporation Limited (DHFL) news that they have been able to raise Rs 4,000 crore. In fact they have got Rs 20,000 crore at all of nine percent. Do you think the NBFC rally is intact?A: As I said the whole sector may not be very expensive. There might be few stocks which may have run ahead of their fundamentals in the short term and this is where we need to be cognisant and we need to be selective. There will still be selective companies in that space which are very promising. I would not like to comment on stock specific basis but it is not that the whole sector is a sell. I would say select companies are still a buy and some of them which have run ahead up fundamentals they might be sell in the same sector. But for a sector as a whole this DHFL bond news actually is a great news that you can borrow such large amount of money from the bond market at lesser rate than what you are paying to the banks. That speaks where interest rates are headed.Sonia: I was just coming back to that point that you were making about the consumption piece picking up . you mentioned a couple of sectors like airlines, media etc but we have also seen good numbers come in from some of the paint companies like Asian Paints, some of the cement companies like Ambuja Cements, auto companies like Maruti Suzuki, but these stocks are not cheap anymore. Would you still stick with the market leaders despite valuations making you a bit uncomfortable?A: Yes, as I said that in our portfolio when we manage we cannot afford to say that because we still believe that we are in the midst of a very strong bull market. I explained to you global bond to equity piece. We don't know where the liquidity can take valuations to. So, we will never take that call that you want to make this sector zero wherever the earning possibilities are still there. So, it is basically your ability to go a little bit underweight and overweight which is what we keep playing tactically.But I personally believe and we personally believe that on a bottom up basis India will continue to throw a lot of opportunities. So, maybe the market- as Anuj was rightly saying- maybe the market in the near term may have discounted a lot of positives from an index perspective but I would still say bottom up opportunities are there and we will continue to look for them.Anuj: Some reality check of course can never harm anyone. We have seen commercial vehicle (CV) sales for example for Ashok Leyland for last two months showing decelerating trend. Auto sales except for a couple of them haven't really don't too well. We keep talking about signs of recovery in the economy but the data somehow is not backing that. At some point that is going to hurt market, right?A: Yes, I agree with you. What has disappointed me personally is this quarter numbers. For select companies this quarter numbers have been very disappointing. In fact I would have expected that those numbers would have been far better. I am still quite hopeful that the second half will see some definitive recovery sign in earnings for companies. But in the near term what you are speaking I can't disagree that markets definitely have run a little ahead of the fundamentals in select cases where the earnings are disappointing and the near term fundamentals are a bit challenging.Latha: As a thumb rule and even in today's particular context at what level will you say this market is a place where you buy and at what points will you wait for the markets to come to your level, speaking of index levels?A: I am not trying to evade the question but you know it is so difficult to call but I would say still I don't see more than 10-12 percent downside to this market if you have to really answer that question that at that level the market will get support - all these events which are supportive in the medium to long term - lot of money you have to - the one thing which is in favour of equities in India that there is such enormous amount of left out feeling from the retail and local investors I cannot tell you because the participation is still 1-3 percent of their overall saving. So, that is what will keep the floor intact for the market and given India's position in the global market and given where the global liquidity is and that is what I explained in detail definitely I don't see more than 10-15 percent downside to this market.Sonia: Since you mentioned global liquidity that could be the only curveball thrown to our markets right, because right now we are seeing some signs of a risk off in the global markets. Would that be a concern for you for the second half of the year?A: Second half we will evaluate again these are large calls to be taken, six months in advance. It is so much data dependent that every day we are getting four data points but I don't think that is a real worry at least in the near term. There is just too much money floating around and the interest rates are negative. People are finding it so difficult to park their money even at zero percent interest rates. I don't see it will all get quickly reverted and it will become a cause of concern at least in the near term. After six months obviously we will have to take another call depending on how the markets are positioned.Anuj: We talk about FII flows but the domestic fund managers have done remarkably done well over the last three or four years in terms of getting the market timing right. What have you made of the recent sell in from Domestic Institutional Investors (DII)? It is quite a bit and on days it is actually outnumbering the FII buying as well?A: A lot of it might be from insurance companies who play contra to the market. They are buyers when there is a crisis and they are obviously sellers and I am assuming Life Insurance Corporation of India (LIC) will be the largest one in terms of selling. I don't have specific information. But I do not think DIIs are taking a cash call, or a very big cash call just because markets have run ahead. There will be a tactical shift from getting away from the overvalued sector or overvalued few companies to what you like but I personally do not know of any fund manager who is taking a 10-15 percent cash call at this point of time.