Here are some fundamental trading ideas from Rahul Arora

In an interview to Prashant Nair and Ekta Batra, Rahul Arora of Nirmal Bang Institutional Equities shared his views on the fundamentals of the market and the outlook going forward. He also spoke about specific stocks and sectors.

Below is the verbatim transcript of the interview.

Prashant: Lots of buzz with regards to some potential M&A in the banking space today; I am sure you have been following everything quite keenly, any thoughts, the only thing we know for a fact that at 3:15 we will have a press conference addressed by Uday Kotak and his team.

A: I think that is probably the big news that everyone is waiting for. It is a bit speculative to comment about what their announcement will be and what the future of Axis Bank will be with respect to the three or four large private sector names that have been floating around that potentially want to acquire it. However, as a house, we are sort of more aligned towards larger retail sector, private oriented banks, so, we are avoiding the PSUs despite the news flow that is there right now because we would like to wait for the fine print.

Even on the larger ones, the likes of IndusInd Bank, HDFC, or even a Federal Bank as oppose to an ICICI Bank is what we are sort of recommending where the asset liability franchise is a lot better. The corporate exposures probably come down quite a bit. So, I think from an aggregate point of view, obviously whichever bank eventually goes in and acquires hypothetically Axis which is the one that is being spoken about, I think there are enough synergies to be talking about.

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We have sort been doing our own numbers, but I think just from a Sebi compliance perspective, I would not want to sort of hazard a guess specifically on what it could mean for Kotak. However, like I said, as a house we are probably more inclined towards private sector banks and have a larger retail focus.

Prashant: We don’t even know whether it is actually an acquisition, but since we are on the subject, if it is an acquisition, we know one party in the deal that is Kotak. There have been names such as Manappuram, Muthoot, etc. which are being talked about as well but purely from that perspective who could be a potential seller in this case or who could be acquired, do you think -- forget Manappuram, Muthoot, let us just consider M&M Finance and Axis for a bit, with NPA levels with what they are etc. somebody like Uday Kotak would pay top dollar, a premium to where prices are trading at and prices have already run up or you think he would strike a hard bargain, a deal which will be good for Kotak, but one can’t be so sure of the seller?

A: If record is anything to go by, I think the last private sector acquisition that Kotak Mahindra Bank made, they made a success of it. From a people integration point of view, and what they have done with the franchise as well, I think there is a fair amount of possibility of M&A, but I don’t know whether it will be linked predominantly from a bank-to-bank perspective. So, I know the name of Axis is sort of floating around, but I think just looking at the NBFC landscape, I think the opportunities there are a lot more.

So, I think the guys that are either getting a small finance bank licence or are in queue, they potentially be better target. So, I know the name of SKS has been being doing the rounds for a while, but I think a lot of these larger NBFCs whether it is an Ujjivan or Equitas eventually become fairly better M&A candidates even though I think the gold lending model is a bit better because you at least have a secured asset to go with and we have a buy on both Muthoot and Manappuram at our house and so also with SKS Microfinance and Ujjivan.

However, if you would sort of pick, gold finance probably is a little better because you actually have some collateral to go with. So, from an out and out bank perspective, I think more from a bank-to-bank perspective while this news is fairly speculative on Kotak, I think bank to NBFCs makes a lot more sense and you have had heard enough buzz about it as well.

The valuations have corrected quite a bit in the case of NBFCs and I think the next one or two years is going to be fairly challenging. So, if the price is right I would not be surprised if some of the larger banks like an IndusInd or some of the other leading private sector banks also go ahead and look at the NBFC acquisitions.

Ekta: That is on finance, what else are you recommending to your clients right now, which sector do you like the most?

A: I think it is a bit of a tough call. I think just the three or four areas where we are positive as a house is consumer discretionary, consumer electricals, autos, and maybe as a contrarian if you want to look at pharmaceutical. I think the rest of the market at this point apart from the banks that I spoke about is a bit of an avoid.

So, we are underweight on capital goods, we are underweight on IT, we have downgraded cement, so, I think there are very few pockets that are looking good like I said consumer electricals, maybe consumer durables.

Ekta: Any specific stocks you want to share?

A: I think on the discretionary side, we have recently initiated on Whirlpool. I think my analysts expect that the earnings of Whirlpool over the next two years could compound at about 25 percent with about a 16-17 percent topline growth and about 100 basis points expansion in margins. It is a 120 percent return on invested capital (ROIC) business coming to you at 25 times, much cheaper to the stock of the month that is D-Mart which is come in due well excess of 40 times.

Inox is another stock that we like, I think the valuation gap with PVR is closing quite well, the movie pipeline is looking good and I think the increase exposure that you are talking about on F&B, and advertising, will aid their gross margins. So, I think those two from the disposable side are looking sort of fairly attractive to us.

We have spoken about V-Guard before, that is another one that we like. So, there are these pockets where if you look at it relative to the market and earnings growth potential, there are enough opportunities that are there. In autos we have recently initiated on Gabriel, it is a proxy to Maruti. Again my analysts is talking about a 20 percent kind of growth over the next couple of years, again 30 percent ROC business. So, I think there are enough opportunities in the market that are linked to where the spending power will go up that sort of investors could be looking at from one or two year perspective.