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Udayan@Moneycontrol: NBFCs not 'attractive' despite steep fall, market has priced a 25 bps rate hike

FIIs are selling out, but SIP inflows are supporting the market so far. If SIPs start diminishing, the market will take a significantly hit.

October 01, 2018 / 06:11 PM IST

The carnage in NBFC shares may not be over yet, CNBCTV18 Consulting Editor Udayan Mukherjee said in an interview with Moneycontrol Editor Santosh Nair.

"You could probably have a situation where these stocks pull back and then they sell-off more because I fully expect the road for the next one year to be quite bumpy for many of these financial names," he said.

Mukherjee expects the RBI to hike interest rates by 25 basis points in its credit policy later this week.

"I wouldn’t put it past the Reserve Bank to do 50 basis points as well. Though, the government might actually be requesting the Reserve Bank to not do 50 basis points because sentiment is already very fragile in the financial markets," he said.

Below is the full transcript of the interview:


Q: Two weeks back when we spoke, you had mentioned that a serious de-rating of Non-Banking Financial Companies (NBFCs) was on the cards and over the last week events have played out that way. We have seen a steep sell-off in many of the big NBFC names. So, how bad is the situation and do you see it getting worse?

A: A serious amount of price damage has happened already. The problem is that the starting valuations for NBFCs were already very high and despite the fact that some of the good ones have also corrected they have not come down to valuations which can strictly be called attractive.

What I expect is that there will be some kind of bounce back in these names, the financials generally because the slide has been particularly one sided and therefore you could see some kind of mean reversion or a pull back. But whether there carnage is over in these names? That I am not very sure. You could probably have a situation where these stocks pull back and then they sell-off more because I fully expect the road for the next one year to be quite bumpy for many of these financial names.

Liquidity is getting tighter in India, there is no doubt about that. Cost of funding has gone up and growth and margins for NBFCs and many financial stocks is under a bit of a question mark. This is not to say that there is no money to be made in the financial sector in India, far from it. But the last two or three years we have seen a massive valuation expansion in most of these names and now you will probably see one year of fairly difficult times for the entire NBFC and for the banking space and the Bank Nifty is adequately reflecting that.

We will of course be news flow driven to some extent, the way the IL&FS problem resolves itself over the next few days, what resolution we find with YES Bank and other news flow driven banks like Kotak Mahindra Bank and Bandhan Bank right now, we will find out and that will partly determine how each of these stocks move. But broadly as a category the regime is now sell on rallies and investors will try to trim their positions and weightages in this sector.

Q: How should investors look at the financial space right now if one is looking to make a portfolio from a slightly longer term perspective? Is there an opportunity in the sell-off?

A: Again I come back to valuations because the answer would have been yes. It is just that valuations have expanded so much that even after the correction they don’t look mouth-watering – the good quality stocks I am talking about. HDFC Bank has not fallen that much and therefore the valuations are not that mouth-watering. But if this carnage continues and if you see some of the high quality private retail banks giving up ground there might be an opportunity there.

If some of the private corporate banks come off significantly because of the overall sentiment then I suspect there might be an opportunity there and in a few good quality NBFCs, some of them exposed to the rural sector, some of them in the auto space but you have to be a bit careful because you do not want to expose yourself too much to areas like housing finance or some of the two wheeler finance companies because two wheeler might go through a bit of a slowdown.

You have to cherry pick which NBFC you are buying and maybe 10 percent of the NBFC universe, some of the strong retail private banks and one or two of the strong retail corporate banks is probably my universe of financials right now. I would still be very careful of public sector banks (PSBs), I would be careful of some of the private corporate banks and some of these news flow driven banks as well and maybe 70 percent of the universe of NBFCs for the next one year.

Q: The general feeling in the market is that till the IL&FS issue is resolved, that will continue to be an overhang on the market as a whole. What are your thoughts on that part of the crisis?

A: I don't see any great resolution for IL&FS barring Life Insurance Corporation of India (LIC) and State Bank of India (SBI) coming up and putting in money into that entity and that is finally what the government will force or request LIC and SBI to do. My bigger issue is where are we going with this? IDBI Bank falters; LIC bails it out. IL&FS goes through hell and LIC plus SBI bails it out, which is looking quite likely.

How much damage will you inflict on some of these public sector institutions? LIC is large, but if it keeps on gobbling these monsters, these dead bodies, these carcasses, at some point even LIC will get sick. We have seen so many of big government institutions like Air India, coming up BSNL soon and maybe now even few years down the line LIC which we are making into deep problem pockets by kicking the can down the grass.

So, my worry is more LIC and what happens to it down the road because of all the things that it is forced to swallow up, rather than whether IL&FS will go belly up or not. IL&FS will have to be bailed out. We all know the consequences, we have seen Lehman in the US and what it did and we are not going to walk down that path. So, it will simmer for a while and it will cause tightness in the bond market, it will cause liquidity constraints. The government will sense that it will lead to complete panic if a bail out does not happen and finally LIC will have to do it.

That is the way I see things progressing but it is an unfortunate episode. Thankfully LIC is not listed otherwise its shareholders would not be sleeping at night. But it just underscores the problems with owning any public sector entity which can at any point be asked to come and do some national service by picking up a dying entity.

Q: We have the credit policy coming up later this week, what are your thoughts there? Do you see a hike in interest rates?

A: I do see a hike in interest rates – we will be lucky if we get away with 25 basis points. I wouldn’t put it past the Reserve Bank to do 50 basis points as well. Though, the government might actually be requesting the Reserve Bank to not do 50 basis points because sentiment is already very fragile in the financial markets.

Bond yields have already hardened to 8.25-8.30 percent and 50 basis points will send it going up again, but there are three forces which the RBI has to reckon with one is core inflation which continues to be strong, second is the rupee which continues to be weak and the third is crude which remains very-very strong and hits new medium term highs every day and the combination of these three trinity of crude, rupee and core inflation makes it quite possible if not certain that we may even get 50 basis points. The market has priced in 25 basis points it will take in its stride, but if we do get 50 basis points – we are staring at another problem and maybe the beginning of another sell-off.

Q: The only saving grace for the market right now is sustained flows into mutual funds and that too largely through the systematic investment plan (SIP) route. Do you feel the events in the bond market like the one we witnessed the week before last, this could affect sentiment on the equity side of mutual funds as well?

A: It has already affect the sentiment if you look at the flows – just look at the last 15 months of equity fund flows you will see many months in 2017 calendar where the flows were Rs 15,000-16,000 crore a month. Even January-February early this year we saw about Rs 10,000-12,000 crore – now the number has come down to Rs 7,000 crore. This is a significant reduction over a period of one year. Basically, the lump sum money is gone the big HNI lumpy inflows into equities is gone now we are not getting that.

I suspect though I don’t have data to corroborate this that even SIP inflows have started diminishing – not hugely but on the margin some of the accounts might have stopped putting in the money. Have big time redemptions happened already perhaps not but if you see this kind of mood continuing in the market the headline screaming IL&FS crisis, Yes Bank fall etc. etc Bandhan Bank crisis everyday – then it is a matter of time that even retail investor start to say, am I doing the right thing by putting in money every month or do I need to go easy for a while, that may not be the advisable route but sentiment is an important thing in the market we all understand that – so for September we will probably see the number at about Rs 7,000 crore odd maybe a little less than that or around that, but my fear is as we get into the October-December quarter we may see SIP flows go down by a Rs 1,000-2,000 crore a month and that is like the life blood of the market now.

Foreign institutional investors (FIIs) are selling continuously, the lump sum PMS kind of money is gone from the market – what is holding the market in one place against the FII outflow is SIP inflows, if that diminishes for some reason every Rs 1,000 crore of fewer SIP inflows knocks the market back very significantly. Technically, if you had to watch one thing right now the SIP flows are the most important.

Q: What is your view on the Yes Bank stock, is there an opportunity there?

A: Price wise, the stock has corrected quite significantly. If I am not mistaken the stock is now down to about close to one and a half times price to adjusted book for this year –now that’s a low valuation. The only problem for investors is to figure out what the RBI is worried about, what is the disclosure which will come out of Yes Bank once the dust settles. Will it be like kitchen sinking, “sorry we told you that my NPAs were this and now it’s actually this” – that is what is worrying the market that this fact of not knowing what lies in Yes Bank.

There have always been suspicions, there have always been rumours that actually their asset quality is very different from what you know – but quarter after quarter Yes Bank management has come out and said “my asset quality is quite fine” till the RBI took the fairly extreme step of asking the promoter to step aside. Now such an extreme step can only mean that the RBI knows what we don’t know and the market is worried about when that disclosure will happen, will be forced to happen and then we will have to take stock of what the real picture.

It is one thing to arrive at a valuation on a price to adjusted book on current facts, but if the facts changed then what are the true valuations that is the dilemma that investors are caught in. I would say that for patience, smart brave investors who want to take a punt in this zone of Rs 150-180 it conceivable that they find value in Yes Bank, but for people who will panic very easily on news flow driven falls – they might be better off waiting and seeing where the dust settles. But if you still see alarming drawdown in the stock from this current level – then a little bit of nibbling might be fine because the value has adjusted quite significantly to the bad news.
Santosh Nair
first published: Oct 1, 2018 06:10 pm
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