UTI's Vetri: Pick stocks rather than sectors, take earnings forecast with pinch of salt

In the current market, one can pick stocks than sectors. “There are phases where stock picking creates more alpha for you,” he told the channel. Although, it may be a challenge as well as the market has moved up in terms of prices and valuations. One has to dig deeper to look for stocks with attractive valuations, Vetri said.

One of the reasons pushing the market higher is increased liquidity. Experts of late have hailed the increased inflow from retail investors into savings schemes such as a systematic investment plan (SIP).

“It is good to see investors putting their money and it’s even better as it is coming through the SIP route. People are allocating small tickets and is happening across a large number of investors,” he said, adding that this willingness to commit to long-term investing is making a difference.

Meanwhile, Vetri believes that resolution on non-performing assets is possible if it is a two-way street. One cannot see only the banks bearing the pain of such issues, it needs a cleanup of entrepreneurial balance sheets as well, he said. This will involve not just writing down of loans, but also of equity of shareholders in current entities. Furthermore, it is important for the resolution to happen in an urgent manner, he told the channel.

There are some PSU banks which are not in a position to absorb this pain due to low capital adequacy. The government will have to take a call on how much money it wants to infuse in banks, Vetri said.

Below is the verbatim transcript of the interview

Anuj: Are you still finding enough stocks to buy right now at current market levels and the kind of big rally that we have seen?

A: It is a bit of a challenge because the market sort of moved up quite a bit not just in terms of prices but also in terms of valuations. So, you have to really dig much deeper to see what is really left in terms of stocks that still offer attractive valuations and where you think growth expectations are not fully built into current prices and valuations. So, it is certainly a lot more challenging at this point of time.

As far as the economic cycle is concerned, there is a fair bit of hope about the next two years seeing a little bit of growth acceleration come through and a lot of that is reflected in the strong earnings forecast that we have both for FY18 and FY19. But history suggest that we need to take these forward earnings forecast with a bit of pinch of salt given what has happened not just in the last 4-5 years where they have fallen short but also if you go back in history these forecast are slightly dangerous to rely on entirely. So, from a valuation point of view there are certainly challenges in this market.

Latha: In your new avatar are you continuing to see the gush of liquidity, no let up at all – domestic investor interest?

A: I think this is something that is build up over a period of time and it is good to see that local investors are putting in money and even better thing about this is that unlike in the past where we have seen huge surges of money those have tend to be more of significant one-time allocations into the equity market and have very often proved to be ill-timed. However, what has really changed in terms of gush of money you are seeing into the market today is really the fact that it is coming predominantly through the systematic investment plan (SIP) route which means that people are actually coming in with the far longer timeframe. They are staggering their investments and hopefully that will give them a little bit more of staying power.

As we have witnessed even over the last two years, I mean if you actually think about it we were at 9,000 even in March of 2015. Two years later we are still at Rs 9,000 and the pipeline of money has only increased and I think the good thing about this is in the past you actually may have seen a lot of disenchantment that the market has gone nowhere for two years, but this time around because people are allocating small tickets and it is happening across a large number of investors, I think both their staying power and their willingness to commit themselves to long-term investing is making a very significant difference as compared to whatever we have seen in the past.

Sonia: The talk is picking up as far as non-performing assets (NPA) resolution is concerned. Vinod Rai, Chairman of Banks Board Bureau has now reached out to the PMO; talking about various solutions that he thinks plausible. According to you what needs to be done urgently to address this situation and how are you positioned in some of the public sector undertaking (PSU) banks?

A: The issue is clearly urgent because we have gone through this whole process of --first of all being very opaque about the fact that there are non-performing assets (NPAs) in the banking system, then we move to a system whereby Reserve Bank of India (RBI) has started to put pressure and said that they want all the banks to come clean in terms of reporting the actual level of NPAs in their book and finally we have also got these multiple schemes through which they are trying to get a resolution or work out of the NPAs. I think it is very important that this gets eventually done because there is pressure both on the entrepreneur balance sheets as well as on the bank balance sheets. If you really want eventually at some point of time down the road a new capex cycle to kick in it is not going to happen till the entrepreneurs balance sheet is cleaned up and the bank balance sheets are cleaned up.

However, the key issue over here in terms of the clean-up, I think we need to keep two elements in mind - one is that eventually many of these loans may have to be written down. I think rightly so as the point has been made this is not a write down of loan which should happen and the full benefit of that transferred to the current equity shareholders; I think the way we need to look at this is that this will involve a write down not just of the loans but also of the equity of the current shareholders in these entities. Without that I believe such a solution would neither be economically good idea and neither would it politically be a good idea.

I think both the current equity shareholders of these enterprises will have to take a haircut and the banks will have to take a haircut and in many cases we have the underlying companies owning assets which may actually be assets which are infrastructure assets or whatever kind of assets which actually are capable of producing a good amount of revenue cash flow and servicing the loans if the loans have been written down. So, I think it is in the Nation’s interest that these assets actually start to operate at full capacity and start to repay debt, but just that we will have to write down both equity and debt and I think that is where we are losing sight of the plot when we only talk about the write down of the NPAs and not about the write down of equity. I think certainly from a free market perspective which is the model that India has chosen for itself it cannot be the case that only the banks take the pain and the entrepreneurs go away scot-free. So, I think the solution eventually involve making sure that both happens simultaneously.

Anuj: If we indeed price in a haircut, PSU banks at current levels looking at the valuations looking at the under ownership is it still a good investment?

A: I don’t want to specifically comment on that but the obvious question that you have to then ask yourself is that if the banks loans have to be written down and there is a significant haircut what happens to capital adequacy of these banking institutions. When you look at that you will find that across the spectrum there are many corporate sector lenders some of whom appear to have enough capital adequacy at this point of time to absorb the pain and then there are some lenders which unfortunately don’t appear to be in the position to absorb a significant amount of pain because their capital adequacy ratios are already very low.

I think it does happen in this case that many of these institutions actually are the government owned PSU banks and therefore I think as part of the solution the government as the owner of these banks will have to take a call on how much money it is willing to place in these banks in order to ensure that capital adequacy is restored to adequate levels. So, I think that will certainly have to be part of the process that the government will have to think through as to what will be its contribution because for whatever set of reasons we do have a banking system in which close to 2/3rd of the banking system belongs to Government of India, its majority owned. So, as part of the haircut process eventually you reach a conclusion where even the central government will have to pony up some equity capital to make sure this goes through.

Latha: Just to come back to your earnings question, we are probably in a different milieu in this current year. I know we have thought that every second half of every year will be the earnings breakout year and it has not turned out to be but this time we have definitely a major tax reform, we have the Aadhaar linked to the Pan Card, we have external balance sheet which is extremely strong compared to recent years, crude is under control. Are the macros shaping up for this finally being the year when earnings growth will deliver?

A: Everything that you said is a fair point and it could very well be the case that this is the year. All I am saying is that we just don’t know and we don’t know for a variety of reasons, we have got another disruption coming up over the next few months in terms of goods and services tax (GST) and again maybe some of these issues will actually benefit a lot of our listed companies because these are the companies which operate in the formal sector. But at the same time I think there is some part of the economy which is feeling a bit of pain both because of demonetisation and in the months forward because of GST which is certainly disrupting the entire informal sector. This might be prima facie good in terms of the economy shifting from informal to formal. The informal sector remains a large part of the economy and if incomes over there were to stumble I fail to see how this will not eventually have a bit of a dampener on some parts of the economy as well.

So, the GST is another big disruption coming up. Is it a great reform for the long-term? It certainly is but short-term impact of earnings is unknown. Longer term we love to position ourselves for companies which will benefit from formalisation of the economy, but in the shorter term it is a bit of unknown. I think the whole global commodity trade, the reflation trade also is looking a little bit more uncertain as we have seen events play out in the US and on Fed policy in recent months. So, in that sense we still need to take a pinch of salt as far as these forecasts are concerned. For no other reason the fact of the future is uncertain and I will also say this much that I think eventually there will come a point where the economy gains momentum, there is traction and at that point you will find that perhaps the forecast are again going wrong because they may just prove to be a little bit too conservative and the economy will do better and earnings will do better. So, that is just the nature of the beast and I think you need to learn to live with that.

Sonia: If you had to rate for us the sectors that you prefer the most and the sectors that you would avoid here on. What would they be?

A: Just two points to make on that particularly given the UTI legacy and wide range of schemes that we sort of manage, all of whom have very different strategies and very different thought process. I don’t think there is one particular strain of thought that I could identify that every single fund is overweight or underweight specific sectors. The second point that I would make honesty is that there are phases in the market where stock picking creates a lot more alpha for you than actually betting on sectors.

I think we have been in that kind of environment for a few years now and I suspect it might persist till we see much clear macroeconomic acceleration. So, I still think this is more of a stock picking market rather than focusing too much on getting the sector right. Our broad thought process right now remains that let us get the stock picking right rather than only focus on sectoral outcomes.