See Nifty closing 2015 near 8K; FII money shrinking: Udayan

Sonia: It is the last part of the year and what an anti-climax it has been. Everyone expected this year to be great after that whole Modi-run, but none of that panned out. What is the sense you are getting about the start of the next year?

A: It has been a disappointing year, but the market set itself up for some disappointment with the kind of rallies that preceded the start of 2015. People generally extrapolate, so it is no surprise that 2015 was built as what should have been another positive year for the markets and the market disappointed or surprised the street a little bit.

I think the jury is still out on 2016. You could argue for or against a positive year for the next year, but the way this year is ending is interesting because the last few days, we have seen volumes dry up quite significantly and taking advantage of the lack of institutional activity, the market has crept up somewhat to give an illusion of kind of a positive closing to the year.

So, we may yet close the year around the 8,000 mark, which will take a little bit of the sting away from that repeated banging against the 7,500 level on the Nifty. So, it is probably not going to be such a bad close to what has been a disappointing year, but as I said, the jury is still out very much on 2016.

Latha: Actually, we are not the only market which has not returned much. In fact, we have probably not destroyed capital as much as other emerging markets have. Even the Dow Index is barely going to finish in the green going by current trends. So, will that be held against Indian markets or will it be positive that at least it did not destroy capital?

A: The call is more an emerging market call rather than an India call at this point in time. I would recommend that you read Russell Napier, if you have not read it already. Russell Napier's call on emerging markets, where he argues that liquidity for emerging markets will shrink considerably going forward. And that is something that we need to keep in mind.

A couple of things which leap out from this year’s performance is the way foreign institutional investors (FII) have started selling out of all emerging markets and that includes India which has been, as you correctly pointed out, an outlier or a slight outperformer. But that has not stopped FIIs from taking money out of the Indian debt and equity market in the second half of 2016.

So, I think a lot of investors globally are taking an emerging market call at this point in time and within that that heavy distinction that we would like to see between different emerging markets has really not played out. If that were the case, then India would have delivered a positive return.

Also, I think foreign investors will also recognise that while the Dow has not gone up significantly in 2015, if you just map India’s dollar performance versus the Dow performance, you will find that India’s underperformance in dollar terms compared to the Dow Jones Index, which is referenced in dollars obviously, is not that insignificant. So, for an American investor who is sitting out there and saying I could get a one percent return from the Dow or I could get a negative 10 percent return in dollar terms from India, what looks more attractive to me? And this is my home ground. Why would I forsake my home ground to take a negative return in another market which people call attractive when I can get slightly better sitting at home?

So, you can say, and I think we are clutching at straws out here, saying that we fell only 6 percent, while another emerging market fell 12 percent. In absolute terms, the return is still negative. So, yes, macro metrics in India are positive, but from a market performance point of view, we need to put our hand up and show better performance for us to attract more capital flows than we did in 2015.

Sonia: But the money that has been coming in from domestic institutions has been the saving grace this year, do you see that continue?

A: I hope it continues. And I think the good point about that is that you can still talk about lots of stocks in the second half of 2015 which has not been good for the overall headline indices which have delivered good returns. In addition to that, you have actually seen the primary markets starting to deliver returns which is excellent news for domestic investors because nothing really excites sentiment or ignites sentiment as much as great capital market returns from the primary market for local retail and high net worth individual (HNI) investors. So, a combination of select midcaps doing well plus initial public offerings (IPO) giving very good returns, the last three have been blockbusters, as you know.

So, from a sentiment point of view, the domestic investor is probably still telling himself that the index has paused and has been grinding in a range, but midcaps are doing well, it has become a stock specific market, we can make money out of IPOs, so there is no reason for us to desert the market immediately. So, the domestic money stays with the market for now. But, as I told you on an earlier occasion, if for some global reason, the market were to go down and break that 7,500 low and go down to 7,200 kind of levels, that will be the first serious test of the patience of domestic money._PAGEBREAK_

Latha: Why not speak about the IPOs. Dr Lal Pathlabs, it has given fairly handsome returns and oversubscribed so many times over, how do you look at that stock itself?

A: As you know, the market loves these kinds of niche stories without too many parallels. So, it is an exciting story, clearly as you can see from the performance post the IPO. The pedigree is good, the track record is good, growth has been decent, balance sheet is debt free, so there are many reasons to like Dr Lal Pathlabs. And there is probably only one reason to re-look at or scrutinise an investment there and that is valuations. And I think the valuations have gone up to a level where it becomes quite difficult to justify purchasing that stock.

So, for people who have bought into the IPO, it may make a lot of sense to book partial profits and lower your cost of entry into that company, and for people who are looking at fresh purchases, they might as well wait it out a little bit because right now, the margin of safety in Dr Lal is virtually non-existent, trading at 44-45 times. Forget the price-earnings (P/E) multiple. For Rs 800 crore revenue company to have a Rs 7,000 crore marketcap is a little excessive. So, if you want to enter that company, you probably should wait for levels sub-Rs 750 or even sub-Rs 700 to get a little bit more margin of safety under your belt. I mean it is a very good company, it is well-run, there is no argument with the prospects. It is just that the valuations have probably run a bit ahead of it and become quite rich for a fresh entry into that counter.

Sonia: What about Alkem Laboratories?

A: That is a simpler call because it is a vanilla company. You have a lot of companies like Alkem which exists in the market right now. It is not a niche or a unique play in that sense, and trading at about 20 times, I think this year, FY16, expected to run in about Rs 70-75 earnings, stock is already at Rs 1,450-1,500. So, you are talking about 20 times FY16 earnings and that is absolutely fair for a domestic focused pharmaceutical company without at least at this point, the huge attendant risks of US FDA exposure, which the company runs a slightly lower risk of. So, it is a vanilla pharmaceutical play, large company, but you do not want to pay too much more than 20 times, just because it was a recent IPO, I mean why would you differentiate between Alkem and an existing secondary market pharmaceutical company just because it got listed three weeks back.

So, I think it is a good company and you want to probably hold on to it, but the juice which was there in company got wrung out between the IPO price of Rs 1,050 and the current price of Rs 1,450. This Rs 400-500 move has wrung most of the juice which was there in terms of valuations. Right now, at best a hold, probably not a fresh buy, but even if it is a buy, it is just like a nice middling kind of a hold play in the pharmaceutical space, not quite with the same attractiveness as a Dr Lal Pathlabs.

Latha: Let me ask you about the sore points of the market. Last time, we spoke about some of the over levered companies, the beleaguered companies and I was asking you if there was some merit in buying them because they are available for peanuts, and you said run for the hills. Actually, we have seen a lot of equity investors coming into some of the Anil Dhirubhai Ambani Group (ADAG) companies, some serious efforts at deleveraging as well as stake sales. Do you think some of these companies now start looking valuable?

A: The signs of the ADAG group are quite encouraging. You would be being unfair to them if you said that they are not encouraging signs to deleverage, but before I talk specifically about the ADAG group, I think it is important to understand why there has been such a big move towards sudden deleveraging. It is not just ADAG; look at the number of companies in the last 30-40 days who have started waking up and trying to do something about their torn balance sheets. I think there is a message out there. The first message to me is, of course, that the Reserve Bank of India (RBI) is nudging banks to come up on their stressed assets and many of these stressed assets belong to some of the companies trying to deleverage, the companies have recognised that there is a clamour for the entire financial system to say you cannot hide some of these bad loans or stressed loans any further, so either banks start calling back some of their poor loans or the companies start getting their act together because time is running out for them and they cannot go on ever-greening them as they have one for the last many years.

So, there is a little bit of a nudge from that side. The other nudge is the point I was making earlier about emerging market liquidity actually contracting and promoters being very smart beasts, they realised perhaps that this is the last innings for them to do something about fixing their balance sheet because maybe, they can see that the emerging market liquidity picture going into next year is such that they will probably not have so many opportunities to get money in into the repair of their balance sheets. Therefore, this hurry to go out and do something before the windows shut down and it gets too late, because in a difficult liquidity environment, as you know, it is very difficult to repair your balance sheet. So, I think these two forces are acting towards nudging promoters to do something about getting liquidity infusions in and in that the ADAG group is trying its own. Many of them are memorandums of understanding (MoU) at this point in time, so I think we will have to wait till fruition of many of these efforts that they are talking about.

On Reliance Communications, which we spoke about last time around, the jury is still out, they are picking up another company or attempting to merge with another company which also has a difficult balance sheet and it is a very difficult sector which is not getting any better, so I would still not get too excited about Reliance Communications. On the other hand, Reliance Infrastructure, which is trying to liquidate its Mumbai metro distribution and dispose of real estate, etc. and the cement plant, that probably might be a better story because if they manage to clean out their balance sheet somewhat, the case for higher valuation for that company is higher.

The short point, I think the group is doing the right thing, it is moving in the right direction and whether these stocks deserve to get a slightly higher valuation point will depend on the fruition of the efforts that they seem to have started._PAGEBREAK_Sonia: A lot of these largecap quality names have started to perform this month, like Sun Pharmaceutical Industries. It has gone from Rs 750 back to Rs 820. Hindustan Unilever (HUL), Asian Paints, have all risen from Rs 800 back closer to Rs 900, any value that you see here?A: For pharmaceuticals, it is a bit of a bounce because these stocks saw massive value destruction in the run preceding the bounce that we are discussing right now. Also, the rally of the last few weeks has had two elements to it. One of course, is that the leadership has not been great. The kind of companies that have bounced in the last run is metals, oil, oil upstream companies, ADAG group. This is not the kind of leadership that you want to see in the market and the other rung has been part defensive where there has been a bit of value destruction which is pharmaceuticals and also flocking back to some of the consumer names. So the rally of the last 30 days is distinctly defensive in one sense and on the other hand it has got poor leadership which makes me a little suspicious of the durability of this rally beyond a point.Sonia: We were talking about some of the largecap names but this year has largely been about midcaps and quality midcaps. If you got your stock right, you would have made lot of money in 2015. Is that the way to go in 2016 as well and where would you see some value now?A: You know how I feel about midcaps. I think there is every reason to be quite bullish on midcaps. It is just that you cannot speak about midcaps as a class because some have done very well and some have not done very well. That remains the theme so far in 2016 as well that stock picking has to be the way for the market.I would be surprised if we had massive headline gains at least in the first six months of 2016. The way the headwinds are shaping up, at best this market will be a stock specific value creator, around the headline levels, I struggle to see if it will create a lot of value.So yes, midcap and smallcaps is very much where you need to be even in 2016 for my money but it is easier said than done. We pick up few stocks and say this went up 98 percent and this went up 150 percent but that is all hindsight.It is easier said than done to pick a midcap, which does very well because the way midcaps operate, the amount of risk attached to buying and owning a midcap is absolutely huge. So for every stock that goes up 100 percent, there are probably two-three which go down 50 percent. While this is a motherhood kind of statement that midcaps will generate better returns, the effort and the skill associated with picking the right midcap -- which will deliver the returns for 2016 -- might be slightly on the higher side.Also, I would say that, while picking midcaps, you need to be a bit careful now because a lot of midcaps, which had value at the start of 2015, have expanded their valuations quite significantly. So in some cases, midcaps are vulnerable to a correction as well if something goes wrong with global markets.While saying that one is bullish about midcaps for 2016, it is only fair to underscore that point that if you are chasing some of the very stocks, which have gone up already then you should know the risk of the vulnerability to a correction if it shapes up on a fairly macro kind of level over the next three-four months.

Latha: What are the bets that the largecaps can be back in the reckoning. The cyclical recovery has to come. We have had two bad monsoons. The third could be perhaps positive; as well you are seeing some bit of improvement in some kinds of urban demand in some goods. Will all this add up and at least second half of calendar 2016 proves to be an earnings growth story?

A: I hope so and it would be fantastic if that turned out to be the case and I do hope like you do that we see evidence of that going forward. Right now all that you have is a glimmer that consumption might pickup and once again we are coming back to the theme because at the start of 2015, all of us were talking about the investment cycle recovering. I hear less and less people talk about that now and the focus seem to have shifted back into the consumption theme once again because investment, the capex theme is just not firing. So people who have got tired of waiting for investments to pickup and now they are going back to Pay Commission etc and say let us see if consumption picks up. I think some of this is in the realm of hope, some of this like consumption might be the stuff of reality in the next two or three quarters. I am keeping my fingers crossed but something tells me that the 2016 story will have a lot to do with how the global economic picture pans out and not just how the Indian economic picture pans out. You might see a bit of fillip in consumption, you might see the investment cycle continuing to frustrate you, you might see very small baby steps towards earnings recovery but if all of that is clouded by a suspicion that global growth is slipping once again then you might have an encore of what you saw in 2015. India not falling as much as other markets but in absolute term failing to deliver the returns that equity investors expect and hope from equities as an asset class. So my big fear is that and not so much whether we will see a bit of an earnings pick up as you are suggesting in the second half of this year.