Companies are just at the beginning of domestic growth picking up, said Anand Shah, Chief Investment Advisor of BNP Paribas MF. Kaustubh Belapurkar of Morningstar Investment Adviser also weighed in.
In order to pick a good fund manager, investors must look at how closely the fund tracks companies’ earnings and similar fundamentals, according to Anand Shah, Chief Investment Advisor of BNP Paribas MF and Kaustubh Belapurkar of Morningstar Investment Adviser.
He said the companies are just at the beginning of domestic growth picking up, adding that the impact of government’s capex increase on roads and railways will have a lagged growth effect.
Shah also said that while earnings growth for private sector banks has been great in the past five years, growth from corporate lending is just beginning.
He added that the revival of rural housing and urban demand will boost cement space.
Below is the transcript of Anand Shah and Kaustubh Belapurkar’s interview to Anuj Singhal and Sonia Shenoy on CNBC-TV18.
Anuj: It all boils down to stock selection. We have seen so many stocks do well over the last 2-3 years but so many stocks have also not done well. What stands out for you, what do you think is working in the midcap stock selection for your fund that we have 31 percent return growth in three years. I see a lot of cement stocks, so is it just about domestic consumption theme or is this more than that?
Shah: What really for us is the teams continued focus on getting the earnings right. So, while we always have a lot of macro issues bothering us every day in and out, what we have continuously done is keep on focusing on ground realities and see where there are turnarounds as well as a good secular story. So in spite of the last 3-5 years of being very difficult on the macro basis, we had many a consumer facing businesses in finance and banking, in consumer staples and discretionary, this did well and actually grew earnings in excess of 20-25 percent through the last five years and that is what worked for us. Yes, I agree with you, some of the turnaround stories again, linked to domestic and consolidation in industry which has also helped the fund to perform so well in the last 3-5 years.
Sonia: We all know that at the end of the day, it is how you pick a good fund manager. And we were looking at some of the returns that these funds have given us. DSP Blackrock for example, the microcap fund has given you a 47 percent return in the last three years. The Reliance Smallcap Fund has given you 44 percent return. Tell us in your analysis, which are the funds that one can perhaps still look into where there could be value and who are the best fund managers that can manage your money or that investors should look at giving their money to?
Belapurkar: As you very rightly pointed out, some of these funds that have done extremely well, what I want to point out here is some of the funds that we spoke about are more on the smallcap, microcap space really. If I look at the DSP Blackrock microcap, they have a very unwavering focus on bottom-up stock research. So, Anand mentioned it. You have got to get your fundamental research right when you are really picking the stocks into building the portfolio. Not only that, you look at the way you are populating the sectors, the way you are doing your risk management in terms of liquidity control, some of these are very important parameters when you are actually go out and when you are looking at a fund manager who is doing the right stock picking.
So, someone like a DSP or someone like a Sunil Singhania from Reliance, they are excellent bottom-up stock pickers and that is what we really like about that to start with. But beyond that you need to understand how do they really manage the risk within that portfolio. So, for instance, there have always been some liquidity constraints in terms of the fund growing too large. They have actually gone out and made prudent measures to keep caps on the number of investments you can get into their particular funds so that the existing investors do not get hurt. So, it is a factor of obviously great research that is being done and some of the prudent measures being taken on the risk management side where we believe these managers bring value to the table.
Anuj: I am looking at your top holdings, IndusInd Bank, Kansai Nerolac, PVR, Cholamandalam Finance, now these stocks are inexpensive. All of these stocks are trading at really rich valuations. So are we in a market where you will have to pay top dollar for some of these growth stocks? Does that still remain the thesis – earnings growth and paying top dollar price for some of these stocks?
Shah: Actually, we have been in such a market for a long time. So, frankly growth is scarce, it might change in the coming years, but if you see on Nifty basis, we have not seen earnings growth on the overall index level for the last 2-3 years. So yes, growth is scarce and if you get the earnings growth right, the stock prices have been rewarded, the companies have been rewarded with the market cap. Also, please understand, we are just at the beginning of the domestic growth picking up. If you see, even while the macros have improved 1.5 years back on the back of lower commodity prices, actually it did not help the earnings through the last 1.5 years. Also, the impact of the capital expenditure (Capex) increase on the roads and subsequently on the railways and others will have a lagged impact on the gross domestic product (GDP).
So, frankly, the combination of a lagged impact of Capex as well as pay commission and the good monsoon reviving some consumption, we will see an accelerated growth or rather the growth picking in GDP and to that extent, the earnings growth rate for the company has been doing well can actually further improve from here as well. So, we will have to weigh between whether you want to sell it too early because we have not seen the complete earnings growth playing out. Having said that, there are pockets of the market which are quite expensive and where the earnings growth outlook is not great and we have actually got rid of quite a few such stocks.
So, it is not one answer for everything. We will have to take each company by company and see. Take an example of the private sector banks. To me personally, while their earnings growth has been great through last five years, but the credit growth is yet to begin on the corporate side. So, so far, whatever growth you are seeing is largely on the retail end. Once growth in the corporate side of lending also picks up, we can actually have a accelerated growth from even these levels.
Sonia: You have a very high exposure to the cement sector. You have names like HeidelbergCement India, Orient Cement, JK Cement, all in your midcap fund, but the fact of the matter is that for many of these companies, say Heidelberg for example, the growth has been paltry. In the quarter gone by, the income was absolutely flat. It did not grow at all. By which quarter do you think the real trigger will come in for earnings revival?
Shah: You are right and frankly, that is the beauty. While in the long run, the stock prices follow earnings growth rate, but that is not always the case. At times, the stock price is ahead of the earnings growth rate. At times, it can be actually lagging behind and it might be doing well only post the earnings growth rate doing well. For us, the play on cement is actually twin. One obviously, revival of rural housing picking up and housing in general which consumes almost 70 percent of the cement demand and the urban infrastructure and road construction activities will help. So, I do not think we have yet seen improvement in the cement demand in general and to that extent, rightly said that we have not seen any earnings growth yet on the cement sector as a whole. So, we will have to wait out for a little more because the sales pickup has to happen before we see operating and financial leverage playing out.
Anuj: The other thing that really stands out in your analysis is that buying one or two funds for most of them, top stock has contributed good 15-20 percent returns and top four or five have contributed almost 50-60 percent of overall returns. Are we getting into a stage where the fund portfolios are also getting very small, very focused, very niche?
Belapurkar: I would not say so. If you look at the dispersion of returns on the index itself is so large, so if you pick the right stocks and if you see some of the funds that we spoke about, it is not just your top 5-10 stocks, but they have actually done a very good job in terms of stock picking and it is your top 20-25 stocks that are contributing to the return. So, out of a portfolio of 40-50 stocks, if you have more than half contributing significantly to the return, the managers are doing a great job. The other thing to highlight is that a lot of these stocks were bought in quite early by the manager and they have actually seen that growth from maybe a small midcap stock to a possibly trending towards a largecap stock. Classic case example being Motherson Sumi or Bajaj Finance which has gone up by 5-10 times over the last five years. So, clearly, it is not just one or two stocks, but it is much more broad based when you look at the top performing funds, and Anand’s fund included where it has been a larger set of stocks that have actually delivered the returns.
Sonia: Your track record has been great so far. 30 percent returns in three years for this midcap fund and 22 percent returns on five years. For someone who has perhaps not participated in this fund just yet, what do you say could be the returns over the next 2-3 years? Will you be able to replicate this kind of record?
Shah: That is more than a billion dollar question. Having said that, what our analysts tell us is that the returns on the funds have been more or less over a longer-term in line with the earnings growth rate. So, I can talk about what sort of earnings growth rate we expect from a portfolio and in the longer run, that sort of returns possibly the portfolio can deliver. And as far as earnings growth rate is concerned, particularly in the midcap segment frankly, it tends that when the GDP growth rate picks up, the operating leverage and the financial leverage is much more in the midcap segment because their margins tend to be lower. I am not talking about all the midcap stocks in general, but a large portion of midcap stocks, midcap companies would have more operating and financial leverage.
And to that extent, our outlook on the economy from here on improves, both on the back of government spending on infrastructure as well as domestic consumption on the back of good monsoon and Pay Commission. We believe that on the largecap side, the general expectation of earnings growth rate is between 14 and 15 percent over the next 2-3 years. We believe that midcap can actually deliver more than 18-19 percent of earnings growth rate over the next 2-3 years.
Anuj: Final thoughts. Your top holding is IndusInd Bank and couple of other like Cholamandalam Finance and Repco Home Finance have done well. But do you get a sense that this space is getting a bit overcrowded, some of the niche private banks and some of the niche non-banking finance companies (NBFC).
Shah: Our general exposure to finance and NBFCs and banking, the common thread between these exposures is business to customer (B2C). Most of our companies, portfolio are linked or rather are doing business with households and that space, even in the last five years was not stressed. We believe and again I am repeating this for the third time, but on the back of decent monsoon and Pay Commission and general improvement on the jobs market, we believe the household per capita income growth rate which has slowed down over the last 2-3 years can again move up. And to that extent, the appetite for retail credit India is quite large, it is still underpenetrated and to that extent, we believe while looks like a crowded and expensive space, we are more focused on earnings growth, we are more focused on opportunity size. And that opportunity size by any means you look at, looks quite big. So, we are more focused on on-ground data, on realities and there we see enough room to grow for at least next decade.