Sanger's question: Will Tatas return to paternalistic growth?

The UK steel assets of the Tata Group are not a viable asset for the company, he maintained. Tata Steel could be one of the three flagship companies of the group that could be affected, he said.

There have been some disappointing numbers from Axis Bank. Loan growth at HDFC Bank and Kotak Mahindra Bank has also slowed. HUL also came out with disappointing numbers. “I think there are honourable exceptions like cement companies,” he said, highlighting how the IT sector is struggling.

Against this background, the Tata Group development shows that its much-hyped premier corporate governance is showing it is not all it is cut out to be.

Tata Motors and TCS are some of the group companies that won’t be greatly affected by Mistry’s ouster, he said. Selloffs do create a buying opportunity in these companies, he said.Below is the verbatim transcript of Arvind Sanger’s interview to Latha Venkatesh, Sonia Shenoy & Anuj Singhal on CNBC-TV18.

Sonia: The biggest cracker this Diwali, it seems was lit by Ratan Tata last week. What is the sense you are getting about how to approach these Tata Group stocks? Do you think that as a long-term investor, one should just sit tight and watch this drama unfold and not panic?

A: At this point, I would say that there is reason to sit on the sideline and if I owned, which I fortunately do not, any of the Tata Group stocks although we were actively looking at one of the midcaps and we have certainly put that on the sideline.

However, the concern that we have is really not about whether there is going to be any legal situation in terms of the ouster of Cyrus Mistry, which is reasonably clear that the board was within its rights to do it although it was done in a very abrupt and unusual fashion. And I do not even think it is as big a deal whether or not there are write-offs to be taken as such like Tata Steel, which frankly, as you have discussed earlier would not be a big surprise.

The big concern I would have is that there was a focus that seems to be coming on return on assets (RoA) and on getting rid of underperforming assets. It seems that some of the things that we are reading about Ratan Tata being uncomfortable with some of the asset sales and some of the tough love, we as investors like tough love. We as investors like paring of underperforming, un-needed bad mistake asset purchases. 

So, if the question is, is this going to be a reversal of some of these returns focus and back to paternalistic growth at all cost or where is the Tata Group growing? I think that is the key reason why I would say that many of these Tata Group companies and Tata Consultancy Group (TCS) is obviously an honourable exception that is not affected by this but many of the other Tata Group companies. These questions raise real concerns about what the focus of management will be.

Latha: I know you said at the outset that you do not own most of these stocks, but the fear from a market standpoint would be a fund which owned these stocks, would they sell off? And let me add a sentence more. The letter from Cyrus Mistry points out to problems with Tata Power, with Indian Hotels, with Tata Communications, that is where he thinks a fair value would be much lower than the current net worth of the groups. But do funds own these stocks? They are more likely to own Tata Motors where he has not pointed too much of trouble. So, should we fear fund selloff?

A: I suspect probably not in at least the flagship names, if you want to take Tata Motors and TCS although I would say in Tata Motors, there are legitimate questions being raised in Cyrus Mistry’s letter. However, it is his point of view, but we will have to wait and see if there is a counter about decisions being made which are not being driven by economic considerations, but by sentimental considerations or other considerations on Tata Motors, but that is a small part of the Tata Motors story. Jaguar Land Rover (JLR) is clearly a success and that is not impacted by this.

So, you are right. The two flagship names I do not think are impacted by this. Tata Steel is clearly impacted by it because if there is an effort to re-engage in the European business and reinvest in that business to make it viable, investors would be somewhat disappointed with that decision where I do not see the strategic benefit of owning a steel company in the UK for Tata Steel to bring really nothing to the table and it is not necessarily a very viable asset by most people who have looked at it. So, that is one of the three flagship companies that we can talk about that would be somewhat negatively impacted if there was a change in strategy.

Anuj: What about the impact on the overall market? I was talking to a couple of respected market participants yesterday and they were saying that you cannot have a situation where you oust a Tata Group chairman and not have a major peak for the market in the near-term. Could this be that trigger that leads to a peaking out of Indian market?

A: If it were in isolation, everything else going fine, I would say that is an unlikely occurrence, but against a backdrop of some disappointing numbers from Axis Bank in terms of their bad loans but also note that the loan growth at two of the better performing banks, HDFC Bank and Kotak Mahindra Bank, you saw significant slowdown in loan growth again because of indications that loan demand is soft and now you have one of the market leaders in the fast moving consumer goods (FMCG) space, Hindustan Unilever (HUL) coming up with very disappointing topline numbers.

So, there are honourable exceptions like cement companies have done very well and so there are some exceptions, but the IT sector is struggling and now you have all these other sectors which are flashing warning signs. And the Tata Group which is considered one of the premier corporate governance groups in the Indian market is showing that maybe even corporate governance in this story, a very well regarded group, is not all of what it is cut out to be. So, in that sense, against the backdrop of everything else going on, it does create the risk that the market could face headwinds. It may not collapse from here but it may have a hard time mounting a sustainable rally till we get some of these clouds clearing.Sonia: How high do you think the possibility of this being a great buying opportunity in some of the well run Tata Group company, maybe not now but maybe once the dust settles a bit in names like Tata Motors and TCS?

A: I think it will. Eventually some of these companies, as you mentioned Tata Motors and TCS, are not areas where there is significant strategy shift that could come about by Cyrus Mistry not being there. Therefore, a selloff in those stocks does create buying opportunity.

However, some of the other smaller cap names, I think there are real questions about strategy shift and therefore how quickly and at what price do they become buys. I think with those two, Tata Motors and TCS could become buying sooner or rather later.

Latha: Are Axis Bank and Hindustan Unilever (HUL) numbers are telling us that the economy is actually weaker and earnings therefore will be weaker than what the market has so far discounted?

A: Axis, at the end of the day, we have known that some of these private sector banks and Axis and ICICI Bank having at the forefront of this concern and to a smaller extent, but not insignificant, Yes Bank, these have been at the centre of concerns about whether the bad loans are fully recognised or not and how many more shoes are left to drop. Therefore, I guess the magnitude of shoe dropping at Axis was clearly startling but the fact that many of these were problem loans and it was a matter of timing or recognition.

It is disappointing that the Indian banking sector has dragged its feet so long to recognise some of these problem loans but we keep hoping that the worst is behind us and as Axis showed the worst is not behind but it doesn't mean that there is a new problem cycle starting. It just means that these individual banks have been very slow to recognise their problem. So I don't see that as significantly market moving; it maybe stock moving for ICICI, if they report disappointing numbers, for Axis it has already happened and may happen some more but you look at numbers of Jubilant Foodworks, which has been a problem child and those were some of the disappointing. Look at HUL; you want to see the FMCG sector showing some positive surprises given many of the FMCG valuations are extremely rich levels and so that is an area we will be watching closely and that would be an area of concern that if you get broader indications or weakness then these two don't by themselves make up a sector but if we get broader indications or weakness then that would be a real headwind for the market. Therefore, as I mentioned, the loan growth numbers from some of the leading banks that have avoided the problems like Kotak and HDFC Bank have been somewhat sluggish and while they pullout good earnings, the loan growth disappointment suggests broader economic malaise, if you will, and that is part of what is concerning us for several quarters, we have been waiting for momentum.Anuj: For last fortnight the two concerns in the market have been what is happening with the fund flows and what is happening in the US in terms of elections and of course the build-up to Fed rate hikes again. What is your sense of how these events could impact the market now?

A: If  there was a surprise, right now it is becoming very likely that Hillary Clinton will be the next President and I do not think there will be big move in the market on that but if there were a surprise and Trump were to win, I think that would cause a selloff in the market and that would affect not just the US but it will effect emerging markets (EMs) hard because there is a risk of a trade war in all emerging markets and even a market that is not as trade oriented as India would still be impacted in any global blowback from Trump victory. So, I am assuming the positive case will play out and there will be no negative surprises, but that is a risk....

Latha: But even otherwise in the last few weeks or at least two weeks we have seen foreign institutional investors (FIIs) selling off in the emerging markets. So is that pro EM trade plateauing out?

A: These flows go on over short periods of time. I do not see this as any major. It is a bit of a repositioning and clearly Fed rate hike becoming a much higher probability maybe part of what is driving some of that EM flows and frankly more about looking for growth opportunities, but I do not see as yet any massive outflows from EM but one of the things that we are getting tired of is the central banker watch and I do not mean so much just the Fed. The Fed is probably on track to raise rates but people are getting a bit more concerned that the European Central Bank (ECB) and the Bank of Japan (BoJ) maybe reaching towards the end of the rope in terms of how much more they can do. So that backdrop of Fed raising rates and if ECB and BoJ are seen at the limits of or reaching the limits of their effectiveness then that can cause some emerging market of course yes, so that is a risk.