Poonawala Fincorp resembles early days of Bajaj Finance: Gurmeet Chadha of Complete Circle Wealth

Gurmeet Chadha, Managing Partner, Chief Investment Officer, Complete Circle Wealth

Gurmeet Chadha, Managing Partner, Chief Investment Officer, Complete Circle Wealth, says the upcoming year will be focused on differentiation, where IT companies that acquire more deals from digital transformations and cost optimisation and those with higher digital revenues will thrive.

In an interview with Moneycontrol, Chadha also spoke about the divide between banks, NBFCs and financial companies. He believes this divide would shrink, and the asset quality and GNPA ratio would see continuous improvement in the near future.

He believes selling by foreign institutional investors (FII) is potentially reaching its fag end and the trend may soon reverse since FII ownership is around the 2008 lows.

Excerpts:

What are your thoughts on the recent drop in IT stocks, and how do you see differentiation playing out in the sector?

You're right. Yesterday, you had the US CPI data, and the US markets were volatile before ending on a positive note. My sense is there will be a differentiation for a lot of IT services companies. We had a very secular rally after COVID in the IT sector.

In fact, I was looking at the BSE IT Index. In the last five years, the index itself is, like, 23-24 percent up, right? So, it has been a very inclusive rally. You are now seeing companies with a higher share of digital revenues. Companies are getting more deals on cost optimization and on digital transformation.

Recently, TCS acquired one of the largest deals from a UK insurer. We've also seen some midcap IT companies, like Persistent, doing very well. Persistent reported a great set of numbers, despite the top three clients not contributing much.

We've seen KPIT Tech making new highs last week. It is basically a company which is into embedded software for auto, which we call CASE -- that is connected, autonomous, shared, electric, right? So it's another niche ERD play within that space. I think this is just the year of differentiation, maybe run-of-the-mill IT companies whose valuations are high would slightly under-perform.

We've seen FIIs being net sellers in the Indian equity market for the past few years. When do you think this trend will reverse, and will DIIs continue to contribute to the rally?

Definitely, at some point in time. Their (FIIs) ownership has been at an all-time high -- around 23.5-24 percent in 2019. Since then, it has steadily come below 18 percent.

In fact, we haven't seen the March data. If you see 2008, the ownership was about 16.5 percent. So between 17.5-18 percent, you're almost at the 2008 level. In terms of the FII data, I am talking about the secondary market in terms of ownership of NSE 500.

In fact, in 2004, when reforms really started, their ownership was around 14 percent. I was speaking to a few portfolio managers, and there is definitely some fatigue after two years of selling.

My sense is that even if you see incremental selling, barring a few days in January, the ticker has come down. In the last two days, they have been buyers.

It looks a little overdone now. I think the key trigger would be when the Fed probably pauses. I think that is probably a couple of months away or we will have to be more data-dependent. So, my sense is that we are probably at the fag end of FII selling.

It is unclear whether DIIs will continue to contribute to the rally. Your views…

Had it not been for DII support, the levels could have been 20-30 percent. Last year, FIIs sold for Rs 2.75 lakh crore and DIIs bought for Rs 2.73 lakh crore. That explains why the Nifty was flat.

My sense is that while the returns have been very flat for the last 16-18 months, the flows continue to be strong -- at least as far as the same numbers go. The EPFO contribution keeps coming. Then there is this balance advantage category, which becomes very big, which keeps rebalancing -- it's a 2 lakh category, by the way, it’s a huge category, average deployment in equity is around 50 percent.

So for every 5-10 percent fall in the market, some money gets rebalanced. If there is aggressive selling, you need a balancing act. I mean, if FIIs continue to sell, probably you will see the market more range-bound.

How do you look at NBFC profiles? There is a typical divide between banks and NBFCs, and financial companies, right? When do you think that would shrink? Even the Economic Survey suggested continuous improvement and asset quality. The GNPA ratio was seen declining from a peak of around 7.2 percent that we saw in June 2021 to 5.9 percent now. What do you make out of it? Are there any names that look attractive?

Yeah, I think there is some pessimism on NBFCs vis-à-vis banks. Banks were reasonably priced and we were used to seeing four or five price book multiples for banks. Suddenly, we're now getting more private banks between two to three price book value multiples.

Axis Bank is below 2 times book value multiple. So I think there was relative valuation at play.

A few of the NBFCs look good to me. Among the smaller ones, I think Poonawalla Fincorp looks very good. Their credit rating is now AAA, their cost of funds have fallen from 9.1 and 9.5 percent to sub 7 percent. So that's like a 250-260 bps fall. It has done pretty well in this environment, and reported a very good set of numbers.

They have guided for a Rs 50,000 crore loan book in the next three years, which is like 40-45 percent growth, and they have very a good digital ecosystem. It's such a small NBFC. It reminds me of Bajaj Finance in its earlier days. I think Chola also looks good. Again, strong set of disbursement numbers, and improvement in asset quality. From the lows of Rs 5,500-5,600 Bajaj Finance has seen some recovery.

So, I think there is some value there. Overall, I think financials, including banks and NBFCs, would give the near-term support in terms of earnings. I think you will probably see 50 percent-plus EPS growth coming from financials.

How do you evaluate the current valuations in the insurance sector, considering the upcoming seasonally strong quarter of March? Despite reporting a healthy operating performance, LIC's stock price has been trading near its lowest level. What is your analysis and how do you approach the insurance sector?

The selloff after budget looks a little overdone. I think the contribution from a lot of insurers on the high-value ticket, which is Rs 5 lakh and above, was about 5 to 6 percent on APE (annual premium equivalent).

HDFC Life was a little higher because their non-par is more than 40 percent in their overall APE mix. You still have a deadline till March 31. In fact, last quarter was one of the best for insurers. Typically, the business you do in the first eight months, you will do in the last four months due to tax planning and year end.

I think you will see very good numbers coming in May. As far as LIC is concerned, I think it has an embedded value of 0.6. A lot, in terms of negativity, is in the price and there's a reason. LIC's share of non-par is pretty low. They want to migrate from participating to non-par. It will take a lot of time coming in. Their VNB (value of new business) margins are still at about 12-30 percent versus 20-25 percent for private insurers. So, I think, if there is incremental progress, probably at around 600 bucks, there is value there.

So, from a near-term perspective, I think earnings and insurance could surprise. We'll have to see how this Rs 5 lakh ticket impact plays out. My sense is the impact would be confined to one or two quarters… it doesn't look like a very long-term impact to me.

In insurance, our penetration is very low. If you remove government insurance and protection, the penetration levels are hardly 6-7 percent. So, it may not enjoy the same multiples, like 4-5 embedded value multiples, but still looks to be a very steady sector as far as the long term is concerned.