Demand in airline space to outstay supply growth: BNP Paribas MF

Private banks and financial companies that are retail-focused are expected to do well in the next two-three years, said Shreyas Devalkar, Fund Manager Equities, BNP Paribas MF. The retail asset growth is expected to be in the range of 18-20 percent, he adds. Private banks with a corporate focus are also expected to grow now that asset quality issues have been recognised. However, public sector banks continue to be a worry. Both liability and capital adequacy issues remain along with stressed asset problem, said Devalkar.The fund manager is also positive on airlines and paint sector. “Paint sector is a good proxy to building material space,” he said, adding that the sector has a high co-relation to economic growth and it has seen consolidation.Airlines, on the other hand, continue to look interesting. The sector is crucial as it has an element of consumer discretionary spend, he said. Entry barriers are low in the sector and “demand is expected to outstay supply growth.”Devalkar likes pharmaceutical sector over the long-term despite USFDA issues. Below is the transcript of Shreyash Devalkar’s interview with Sonia Shenoy and Latha Venkatesh on CNBC-TV18.Sonia: I wanted to first start off by talking a little bit about your midcap fund. You have had a lot of exposure to the financial space within your fund. How have you read into the earnings of the financial sector so far and on private banks, especially, would you increase you allocation?A: On the private sector bank as well as financial side, what we are normally looking at is the retail space. In India, the retail asset penetration is very low. So, the retail asset growth is expected to be 18-20 percent over next 3-5 years. With that kind of growth, in the retail assets followed by the better underwriting standard and the good credit quality, this sector remains very lucrative for us. And that is where we have a huge exposure to both private sector banks as well as nonbanking financial companies (NBFC) and more so in the midcap fund. The more exposure is to the NBFCs. On the asset side of most of these private sector banks, these banks are having good exposure to various segments of retail assets which includes commercial vehicles (CV), which includes rural, which includes passenger vehicles (PV) as well and because of these, the good asset quality as well as on the liability side, they are gaining the current and savings account (CASA) market share and their cost of funds is much better, their capital adequacy is much better. Again, their valuations are superior and that is where they can raise the funds at better valuation as well. And hence, they can grow faster. So, because of all these reasons, the retail focused private sector banks, as well as NBFCs are of choice for us.Latha: That point is taken about the superior performance of the retail guys, but you also have decent amount of holding in Axis and ICICI Bank where the retail focus is probably 40 percent, it is more a corporate facing bank. Should we expect that you will veer more towards the retail banks within the mix itself?A: our exposure in the banks, since when it began more two year ago, we are more focused on the retail focused only. We have added exposure to the banks which you are talking about more off late. Primary reason for that is that now the asset quality is being recognised in the market. You know the exact accounts, you know what is happening and there is a coordinated effort by the regulator, the courts, the governments and the banks itself to actually come over this issue and because of this, we have added certain corporate focused banks, wherein we believe that poor asset quality and wherever there are NPA issues, they are more priced in today than earlier.Latha: Let me just this question then because that is top of the market interest at this point in time – Bank of Baroda. I know you will not talk specific stocks, but will you extend this argument about corporate banks that the poison is now know, that there is a concerted effort by the law makers, courts and the regulator to recovery them. Will you extend that argument to some of the top public sector banks as well?A: When I began talking about the banks particularly, what we look at is first the liability part of it and how the fee based income is growing, what is the strength of liability as well as the capital adequacy. So on this count, most of the PSU banks do not peak and that is where we are not so much positive on the PSU banks. Again there is a question of the management, quality as well and that is where we are more on the private sector side than the public sector.Sonia: The space that you have a significant amount of exposure is in the paints space, so both Asian Paints and Kansai Nerolac is what you have in many of your funds. Can you tell us what the future of this sector is because most of these stocks are sitting at fresh highs? How much value do you see here now?A: In paints sector, what we have seen is there are 3-4 players in this sector first of all. Secondly, the leader in this sector is very much focused on the growth as well as right pricing. It is not having a high profit so that the lot of player enters. So, that is where the sector is relatively consolidated than any other building material sector. And, this sector has very high correlation to the economic growth as well as the housing growth. So, it has a good multiplier effect as well. So, because of this reason, the paint sector is good proxy to building material space. It is also beneficiary of fall in the commodity prices so far and over a cycle. So, if you look at 3-5 years, its gross margin as well as earnings before interest, taxes, depreciation and amortisation (EBITDA) margin has remained constant irrespective of the commodity cycle. There can be a couple of quarters where you can see the adverse impact the commodity in the results, but then over a period of 1-2 years, broadly, these companies have managed their gross margin as well as EBITDA margin and that is why we are positive on this sector.Latha: You are famous in the market, almost legendary in the market for your midcap fund particularly. So, I wanted to ask you about those commodity stocks, sugar and even stocks like paper for instance. Very extraordinary performance coming in from the sugar stocks, would you still dwell in them or is it profit taking time?A: As far as we are concerned, we are not having much exposure to these. Only one stock is there which is having exposure to this space and in that stock there are a couple of other triggers apart from the sugar. So, broadly our exposure to this space is broadly not there as of now.Sonia: The other space that you have an exposure in is aviation. You have Jet Airways in your midcap fund. It has been a dream run for this stock from the Rs 300 to Rs 650 over the last one year. From here on, what would the triggers be?A: Airlines remains very interesting space for us, and we entered this space almost two years ago when the sector consolidation began. This space is very crucial because it has an element of consumer discretionary spend. It also go helped by the fall in crude oil prices wherein the right price point for the consumer to travel is somewhere around Rs 5,000 and that got hit because of the fall in crude oil prices. And there we have seen the demand growth which is as high as 24 percent in the last couple of months. So, because of the faster demand growth, we actually entered and there was a trigger and it was triggered by sector consolidation. So, a couple of years ago, Kingfisher and then SpiceJet had to cut down on their capacity addition. And that is where the supply growth was lagging the demand growth.Going ahead, we believe that this sector is very crucial because here, the entry barriers are low. So the capacity can come easily, but then considering today’s environment where the funding is very difficult to get for anyone be it equity funding or debt funding and that is where the demand growth is expected to offset the supply growth. And particularly, some of the players are focusing on profitability, that is why they are not expanding their fleet as well. So considering this, the sector’s health is much better today than earlier and that is where we are in broadly both the stocks in this sector.Latha: speaking of sector’s health, new set of healthcare stocks have become interesting. All of them entered the IPO market in the last one year or so. I am referring to Thyrocare, Alchem Labs and Dr Lal Pathlabs. Is that an area that interests you?A: It is very interesting area because actually one of them is a pharmaceutical company and the other two are mainly in the healthcare space. So, in the pharmaceutical space, broadly, we are positive on the long-term prospect of the pharmaceutical space in particular. So, USFDA issues are hampering the growth in the near-term. But on the healthcare services space, these sectors are emerging more because here these sectors are getting consolidated mainly because the importance of machine is more in certain therapy. It can be pathology, it can be cancer, it can be for that matter even eye care. So, some of the segments where the importance of machine is much more, there you can actually corporatize that entire segment and profitability, if you look at returns on capital employed (ROCE) of that segment are much better.And there you are seeing actually the benefits of sector consolidation as well as organised market creating much better wealth than the unorganised market. Below is the transcript of Shreyash Devalkar’s interview with Sonia Shenoy and Latha Venkatesh on CNBC-TV18.Sonia: I wanted to first start off by talking a little bit about your midcap fund. You have had a lot of exposure to the financial space within your fund. How have you read into the earnings of the financial sector so far and on private banks, especially, would you increase you allocation?A: On the private sector bank as well as financial side, what we are normally looking at is the retail space. In India, the retail asset penetration is very low. So, the retail asset growth is expected to be 18-20 percent over next 3-5 years. With that kind of growth, in the retail assets followed by the better underwriting standard and the good credit quality, this sector remains very lucrative for us. And that is where we have a huge exposure to both private sector banks as well as nonbanking financial companies (NBFC) and more so in the midcap fund. The more exposure is to the NBFCs. On the asset side of most of these private sector banks, these banks are having good exposure to various segments of retail assets which includes commercial vehicles (CV), which includes rural, which includes passenger vehicles (PV) as well and because of these, the good asset quality as well as on the liability side, they are gaining the current and savings account (CASA) market share and their cost of funds is much better, their capital adequacy is much better. Again, their valuations are superior and that is where they can raise the funds at better valuation as well. And hence, they can grow faster. So, because of all these reasons, the retail focused private sector banks, as well as NBFCs are of choice for us.Latha: That point is taken about the superior performance of the retail guys, but you also have decent amount of holding in Axis and ICICI Bank where the retail focus is probably 40 percent, it is more a corporate facing bank. Should we expect that you will veer more towards the retail banks within the mix itself?A: our exposure in the banks, since when it began more two year ago, we are more focused on the retail focused only. We have added exposure to the banks which you are talking about more off late. Primary reason for that is that now the asset quality is being recognised in the market. You know the exact accounts, you know what is happening and there is a coordinated effort by the regulator, the courts, the governments and the banks itself to actually come over this issue and because of this, we have added certain corporate focused banks, wherein we believe that poor asset quality and wherever there are NPA issues, they are more priced in today than earlier.Latha: Let me just this question then because that is top of the market interest at this point in time – Bank of Baroda. I know you will not talk specific stocks, but will you extend this argument about corporate banks that the poison is now know, that there is a concerted effort by the law makers, courts and the regulator to recovery them. Will you extend that argument to some of the top public sector banks as well?A: When I began talking about the banks particularly, what we look at is first the liability part of it and how the fee based income is growing, what is the strength of liability as well as the capital adequacy. So on this count, most of the PSU banks do not peak and that is where we are not so much positive on the PSU banks. Again there is a question of the management, quality as well and that is where we are more on the private sector side than the public sector.Sonia: The space that you have a significant amount of exposure is in the paints space, so both Asian Paints and Kansai Nerolac is what you have in many of your funds. Can you tell us what the future of this sector is because most of these stocks are sitting at fresh highs? How much value do you see here now?A: In paints sector, what we have seen is there are 3-4 players in this sector first of all. Secondly, the leader in this sector is very much focused on the growth as well as right pricing. It is not having a high profit so that the lot of player enters. So, that is where the sector is relatively consolidated than any other building material sector. And, this sector has very high correlation to the economic growth as well as the housing growth. So, it has a good multiplier effect as well. So, because of this reason, the paint sector is good proxy to building material space. It is also beneficiary of fall in the commodity prices so far and over a cycle. So, if you look at 3-5 years, its gross margin as well as earnings before interest, taxes, depreciation and amortisation (EBITDA) margin has remained constant irrespective of the commodity cycle. There can be a couple of quarters where you can see the adverse impact the commodity in the results, but then over a period of 1-2 years, broadly, these companies have managed their gross margin as well as EBITDA margin and that is why we are positive on this sector.Latha: You are famous in the market, almost legendary in the market for your midcap fund particularly. So, I wanted to ask you about those commodity stocks, sugar and even stocks like paper for instance. Very extraordinary performance coming in from the sugar stocks, would you still dwell in them or is it profit taking time?A: As far as we are concerned, we are not having much exposure to these. Only one stock is there which is having exposure to this space and in that stock there are a couple of other triggers apart from the sugar. So, broadly our exposure to this space is broadly not there as of now.Sonia: The other space that you have an exposure in is aviation. You have Jet Airways in your midcap fund. It has been a dream run for this stock from the Rs 300 to Rs 650 over the last one year. From here on, what would the triggers be?A: Airlines remains very interesting space for us, and we entered this space almost two years ago when the sector consolidation began. This space is very crucial because it has an element of consumer discretionary spend. It also go helped by the fall in crude oil prices wherein the right price point for the consumer to travel is somewhere around Rs 5,000 and that got hit because of the fall in crude oil prices. And there we have seen the demand growth which is as high as 24 percent in the last couple of months. So, because of the faster demand growth, we actually entered and there was a trigger and it was triggered by sector consolidation. So, a couple of years ago, Kingfisher and then SpiceJet had to cut down on their capacity addition. And that is where the supply growth was lagging the demand growth.Going ahead, we believe that this sector is very crucial because here, the entry barriers are low. So the capacity can come easily, but then considering today’s environment where the funding is very difficult to get for anyone be it equity funding or debt funding and that is where the demand growth is expected to offset the supply growth. And particularly, some of the players are focusing on profitability, that is why they are not expanding their fleet as well. So considering this, the sector’s health is much better today than earlier and that is where we are in broadly both the stocks in this sector.Latha: speaking of sector’s health, new set of healthcare stocks have become interesting. All of them entered the IPO market in the last one year or so. I am referring to Thyrocare, Alchem Labs and Dr Lal Pathlabs. Is that an area that interests you?A: It is very interesting area because actually one of them is a pharmaceutical company and the other two are mainly in the healthcare space. So, in the pharmaceutical space, broadly, we are positive on the long-term prospect of the pharmaceutical space in particular. So, USFDA issues are hampering the growth in the near-term. But on the healthcare services space, these sectors are emerging more because here these sectors are getting consolidated mainly because the importance of machine is more in certain therapy. It can be pathology, it can be cancer, it can be for that matter even eye care. So, some of the segments where the importance of machine is much more, there you can actually corporatize that entire segment and profitability, if you look at returns on capital employed (ROCE) of that segment are much better.And there you are seeing actually the benefits of sector consolidation as well as organised market creating much better wealth than the unorganised market. Latha: So, the valuations are yet not daunting for you? Still buyable?A: Yes. As far as we are concerned, broadly in our portfolio, the stocks are not there mainly because of the valuation.