Are you throwing darts at NBFC stocks? Ace mgr says think again

Stock markets are back in favour boosted by hopes that a pick-up in one of the world's fastest growing economies is under way.But as has been the case always, there is a connection between price and value -- and at a particular price, most markets or stocks become expensive, or cheap.The hottest space in the market currently is that of non-banking financial companies (NBFCs). The thesis is simple. As niche companies, they are poised to making deep inroads into India's highly under-banked economy and carve out excellent opportunities in areas where large banks' one-size-fits-all strategy doesn't work.But Sunil Singhania, CIO - Equity at country's third-largest asset manager Reliance Mutual Fund, thinks those making easy money buying NBFC stocks must re-think if the strategy is worthwhile anymore."Making money [in NFBCs] has become so easy. So you take start taking a call [whether you should continue to buy]," he told CNBC-TV18's Anuj Singhal in an interview.To be sure, Singhania continues to think that the opportunities for NBFCS -- especially those in the niche space -- are still large. It is just valuations that may be over-extended.In the same theme, he favours similar companies that benefit from a shift of savings from physical to financial assets such as broking firms, asset managers and insurance companies.He also touched upon the broader market, saying the tide of easy liquidity had lifted all boats and that perhaps companies need to be valued higher on a price-to-earnings basis as their cost of capital had gone down."The trend of 15.5 times [PE] is something that we got used to but the trend is changing now as liquidity is available in plenty in the world and the cost of debt has fallen to all time lows," he said.Singhania, who achieved fame as a noted stock picker, thinks there is plenty of opportunities in the consumption space, and weighed in with his views on liquor stocks and companies such as PVR, which could benefit from pick-up in spending.

"We are a huge country and our standard of living is improving," he said.Below is the excerpt of the interview.Q: Are we going through the hope taking precedence over fundamentals phase right now?A: In a lot of stocks yes, and you have to be careful. Only one difference, what is happening is - I have repeated it time and again - maybe the 15.5 times earnings which we were accustomed to for last 15-20 years is changing because the world is in a situation where liquidity is available in plenty. The cost of debt has fallen to all time lows. In US we have 1.5 percent. In Japan you can borrow 40 year money at negative rates and so on and so forth and same is the case with equities and so much liquidity that even equity is available in plenty. So, maybe the weighted average cost of capital calculation which we do in our calculation that itself has come down and that might warrant raising of normalised Price-to-Earnings Ratio (PE) band maybe 10-15 percent higher and that is what we are seeing right now.Q: 10 plus 15 percent higher is fine but we are trading much above median valuations and maybe near historic high valuations but of course that is global in nature right now. Do you get a sense that something bad could happen globally and the market is not prepared for that. Do you get that ugly feeling sometimes?A: One is I won't agree that we are at historic high valuations. We have reached situations where we were 30 PE in 2008.Q: That was an aberration?A: Aberrations keep on happening. That is not to say that it can't happen this time. I am just making a point. The other thing is obviously you have to be looking at or analysing your positions or your investment on a day to day basis and as I said there are stocks there are sectors where it is getting out of hand. But whether they can still rise 15-20 percent before falling that can always be the case. But as experienced investor who have burned their fingers time and again over so many years we tend to get a little bit more wiser. So, that phase is frankly good for us.Q: In your own industry do you think valuations are getting out of hand, the Non-Banking Financial Company (NBFCs)?A: So, niche NBFCs there is a lot of potential. Frankly making money in NBFC suddenly is becoming so easy. There are companies where the market cap is multiples of their assets under management (AUM), not their book or the price earning. So, you have to start taking a call and one exercise which we normally do is try to analyse what the market price is discounting at this point of time. So, if a company is trading at say 40 PE unless you can justify that in four or five years that company's earnings can triple it would be foolish to pay a 40 PE. Same is the case with NBFCs. Suddenly it has become so easy, you will raise money at three times book. Again you become two times book, again people say that you will become three times book, it is becoming too easy and there is huge potential in this space but you have to be cautious on some of those names. Q: One thing we have learnt is that making money in stock markets is not easy so does that itself raise some alarm bells that now it has become easy, there is a good chance that at whatever price you buy some of these NBFCs, you would have made money?A: I think there is a portion of niche NBFCs where we feel there is still lot of value to be unlocked and I always again say that India is behind the world and that is an advantage to us as investors because what has happened in the world is ultimately going to happen in India.So niche NBFCs which are going to be beneficiaries of the shift from physical savings to financial savings like mutual funds, life insurance companies, wealth management, I think they will make a lot of money.Q: I remember reading an interview of yours where you moved to high risk, high return stocks. You said time to be defensive is over, it is time to just go out and buy some of these high risk stocks. Are we still in that phase or is it time to get into some bit of defensives now?A: I don’t understand the definition of defensive and aggressive. IT can be defensive but it has not performed at all; I am just giving an example. I think what is basically the definition of defensive is where there is sustainable growth and obviously high risk is where the growth can be volatile or it is not as obvious. So, I think at this point of time a lot of defensive stocks specifically on consumer staples have very low growth. So, if you are growing at 5-7 percent in volume terms, for us to justify a 35-40 PE for them becomes a little bit difficult.Having said that, India is a great country, it is a huge country, we are coming out of that cycle where standard of living has improved and some of these consumption names might spring a surprise. However, if you are banking on India, going from 2 trillion to 4 trillion which at least we believe, we have good monsoons, goods and services tax (GST) is behind our back, government, a lot of action is happening, demand is reviving after three to four years, so, you might suddenly see some of these so called companies which are not growing like the capital goods space, suddenly spring a surprise. So, I think yes selectively you have to start looking at them.Q: You recently went Montreal as well and you met a big market guru there as well, you want to tell about that story?A: Montreal or Canada, largest investors there are pension funds. So I met the CIO of one of the large pension funds stationed in Montreal. In May that was a big trigger point at least for me. The bottomline was that they had to generate 6-7 percent or they have to generate 6-7 return on the corpus to fulfill their pension obligations. The world is such that they are not even able to generate 2 percent and they were looking at countries which had relatively stable currency which India was and is even now and which were able to give them 11-12 percent on a longer timeframe and where they could invest in size.So, I think it was very clear that commercial real estate where there is a fixed rental, road assets, power assets, utilities, they will all be lapped up eventually or it is a matter of by some of these large pension funds. We are already started to see the first phase of it, at least I, in fact as a company, we remain very positive of huge flows coming into so called boring sectors which give you 10-12 percent return on equity (RoE) but over a period of 20-25 years. So, I think that was something which was frankly at least, we had not thought of in such great detail. Q: Which are the other books that have inspired you in equities and which are the other books that you still refer to even if you have read them many times?A: I have read a lot of book. I don't remember the name. It is about the first book, I will recollect the name. But right now I am eroding the Fortune's Formula which is more about poker and the bottom-line is simple, if the odds are in your favour bet big.Q: What are the similarities between poker and stocks?A: Again it is about odds frankly. That is one similarity which I would like. So, if there is consensus then obviously it makes sense to be away from consensus. Poker is all about odds. So, if you suddenly find that odds have become such good that even a small probability might give you a big return. It is like that in equities. So, in the portfolio you have to have 5-10 percent of the stocks where you know there is nothing expected from the consensus but slight positive might lead to a big spurt. So, I will give you an example. We have a gold finance company in our portfolio. It was very cheap, six months back. We believe it is still cheap despite having run 100 percent. But the only headwind which we used to get was that gold priced don't seem to be rising and the moment gold prices rose 10 percent the stock went up by 100 percent. So, certainly a lot of these stocks you will start to see that the odds of betting have become very favourable to you.Q: But what if the gold prices fall 10 percent. How do you manage that risk?A: Again as I said it is all about the mindset. Nothing changes fundamentally in a significant way if this happens but the valuations are such that even if nothing were to happen to gold prices in three years time the book value would have gone up by 50-70 percent. So, even in the worst situation you would have ended making 15 percent compound annual growth rate (CAGR).Q: I was talking to one of the biggest sell side research heads and the conversation was about PVR. I know you won't talk stocks but at Rs 600 I thought PVR was expensive. He said he will be surprised. At Rs 1,200 I thought isn't PVR expensive, he said he will be surprised. I am doing some normal calculations in terms of number of movies and the blockbusters and all. I am not able to fathom out how PVR can deserve this kind of valuation. What is the market betting on?A: I will give you a perspective. In Hindi movies if a film did Rs 30 crore for example it was a blockbuster. In Amitabh Bachchan's time if it did Rs 2 crore it was a blockbuster. Then the days of Rs 100 crore club came in. Now we have movies have movies which are doing Rs 300-400 crore. But then if you look at the global perspective. Avatar did USD 1.5 billion. The mid range movies in the US do USD 100 million. So, there is a huge potential. Obviously, I am not saying that PVR is expensive or cheap or some other companies are expensive or cheap. But we are a huge country. The standard of living is improving. We are paying USD 6-7 for a ticket. At least we did not think that. In my youth we used to get video cassette for Rs 10 to watch an Amitabh Bachchan movie. I am just giving you a perspective. And then the full family used to watch it. Q: Talking about some of the other aspects of your life, some of the people who have influenced you and some of the books that you have read that you have found good, is there something that has told you that this is a complete no-no for me, has there been any anecdote which has told you this is one area where I will not invest or I will never invest, has there ever been anything like that?A: As I said, in 20 years of investment history, we have done a lot of mistakes and we continue to do mistakes. I think as long as we don’t repeat the mistakes it is fine. In 2007 and 2008, like most of the people we also believed that capital would be available cheap forever and we invested a lot in companies which had huge investment plans and were banking on a lot of cheap capital, both equity and debt coming in. Post Lehman nothing happened, in fact it reversed, so equity was not available, debt became expensive and we definitely burnt fingers in a lot of these companies.So, I think what we have learnt is basically focus on at least foreseeable cash flow. So, if cash flow is not visible today, whether it is at least visible in the next year or the year after that or the year after that. If that is not the case then it is better off allowing others to make money in that stock, we will avoid it. So, I think some of the construction companies for example, despite our bullish view on the Indian infrastructure story, on the Indian construction space, our view is that unless the balance sheet is capable of executing these projects, no use of becoming a hero and trying to bet big on them.Q: So that has been one of your regrets in 2007, getting carried away a bit?A: I won’t say we got carried away a bit. I think the environment was such and we did not get time to correct it but it is fin; it is a way of life. We made a lot of money between 2003 and 2007, we gave away some of it. However, the good thing was that at the first opportunity, we were able to exit.Q: Which have been your best investments?A: There have been a lot of investments, Jindal Steel and Power in the hay days, Kirloskar Brothers, PVR has been one; we were very early in that space, pharmaceutical we were very early. I would call UPL as our good investments. Despite the alcohol sector not doing well, I think that has been a good investment and we remain positive on that sector.NBFCs we were early though Bajaj Finance frankly we owned 10 percent at one point of time when no one was looking at it but we sold out very early, so around Rs 1,500-2,000 we were out. For full interview, watch accompanying videos...