The outperformance of the Indian markets is extraordinary. What is leading to this outperformance? Are markets now getting slightly carried away because of complacency and or do you think the outperformance is here to stay?
There is a saying that either you can get good news or good price and very clearly we have seen both sides in a matter of 18 months. In March 2020, we did not have an iota of good news. We actually had the bluest of blue chips available at a reasonable price but a lot of the market was available cheap. Today the economy is healing. Things are getting better. Some of the sectors actually surprised us significantly in terms of profitability and cash flows even in the Covid year and net-net, the impact of the pandemic on the strong businesses was not as much and to that extent, the market is going to the other side of the spectrum which is definitely expensive.
We are also worried about the pricings at which IPOs are coming through. In that part of the market, it looks like people are getting a little greedy or there is some sort of euphoric valuations in the consumer facing or services businesses and the tech companies that we are looking at. Having said that, this is also an opportunity to do a little bit of bottom-up stock picking because as the economy is healing, pockets of the economy will emerge and get better.
We are coming out of very difficult times for the economy. Not only the last two years, but even in the last four-five years, we had one shock after another which set back the economy. There is an opportunity to do some stock picking here.
Most of the mutual funds normally run a mandate that by and large they want to be invested; the cash levels may be 5-6%. In this market, how are you ensuring that you avoid greed and yet are able to generate positive returns?We take equity and debt calls while allocating assets. At this point of time, we would have lower equity and higher fixed income. In the equity funds, the mandate is to stay invested because the asset allocation is done by investors or the advisor of the investors. When investors give money into our equity funds, the mandate for us is to stay invested. Secondly, all is not gloom and doom.
To be very honest, today we are seeing pockets where we can invest in the market. The manufacturing sector has been struggling for most of the last decade. They had problems of high debt or of deflation being exported out of China where overcapacities left most manufacturers with very low profits and lower return on equities. So, that sector has almost got off the radar of the investors. Infrastructure is another space, where the government has been continuously spending and private sector capex was almost absent in the last 10 years.
Today, manufacturing is doing very well, profitability is picking up and on top of it, they have announced capacity expansions. So, we are seeing some green shoots as far as private sector capex is concerned. Construction, real estate are always a big driver of jobs and a big driver of the economy, given that a lot of indirect employment comes from construction. Real estate is picking up, especially the residential real estate in pockets of the market as jobs have come back. IT salaries are going up.
We are finding that there is a room to go a little deeper into the economy, deeper into the markets and see where the valuations are still reasonable and growth prospects are improving. That is what we have been doing in our portfolios also. Today we have more manufacturing and a little bit more infra in the portfolio than otherwise we would have had. Also within services, we are looking at services which are more dependent on recovery like banking. Within banking, we are looking at more corporate oriented banks which are dependent on recovery and profitability of corporates.
You are talking about the comeback of the capex cycle after almost a lost decade. Are you doing it indirectly whether in manufacturing by investing in steel companies or indirectly playing real estate surge?
Some of the manufacturing is also benefiting from global macros and to that extent our large weightages are in the sectors which are benefiting from global macros as well as local macros and steel is part of it.
Textiles is another area where we are benefitting from India’s competitiveness while China is withdrawing from the exports market, particularly in steel. We do like residential real estate and that is part of the portfolio. We are also very keenly looking at private sector capex drivers. We have more consumables in the private sector and some of the capital goods play in our portfolio. So yes, it is fairly early. It is too early to call for a complete revival for private sector capex. There are still green shoots and we are watching that space. There are valuation issues but it is in the pocket, it is in the B2C consumer facing businesses. Part of the services industries consist of high return on equity, low capital intensive businesses. This has been the mantra in the market for the last decade, where if a company has a high return on equity and low capital intensity, people have given it 50-60-70-80 PEs. Some of them are not making money and still they are getting very high valuations.
But these are the so-called old economy companies but they are coming out of a lost decade as China reduces its focus on manufacturing and it reduces the deflation it has been exporting into manufacturing industry globally.
When you talk about wage inflation, how will the IT sector’s fantastic growth and consumption be reflected in the portfolio? In 2018 you had taken Asian Paints. But if I were to look at your top 10 stocks, discretionary consumption is absent?
Indeed. We have been very clearly avoiding both discretionary and non-discretionary consumption stocks in our contra portfolio. It is basically priced to perfection and at times we are finding it too expensive. No doubt the prospects are good, no doubt the per capita income in India will continue to rise and to that extent, some of the consumption parts of the economy will continue to do well. We are also seeing consolidation in some of those areas. I am not saying that the prospects for the consumption sector and the consumer nondurables is not great, it is just that the valuation is not attractive at this point of time.
Is there any pocket where you worry about the valuations to a higher degree besides consumer stocks? Is there any pocket where you feel there is a bubble in the making?
More than sectors, I find the prices at which the IPOs are coming in a little worrying. To be very honest, even in the IPOs in the old economy sector, if I compare the listed space with the unlisted, we are finding that at times the valuations are far more expensive in IPOs which otherwise should have been at a discount, give that the company does not have a history and a track record in the listed space. I think that is a little aberration.
So one part of the market that we have been looking through a fine lens and have avoided most are IPOs. That is something which retail investors should be conscious of before they look at it as a flip opportunity. Second is new tech companies. We keep on talking about the disruptors. Again, these are the businesses which do not have cash flows but nevertheless they have built a lot of consumer franchises for themselves. This is another segment of the market which we are trying to understand more.
We are trying to see how to evaluate them as the traditional valuation metrics like free cash flows, the discounted cash flow methodology are very difficult to deploy at this point of time, given they still would have another three to four to five years of negative free cash flows and more equity is in the offing. So that is another space where again we are not fully comfortable yet but we are still evaluating that sector.
ET Now: Have you completely missed out on the new age tech IPOs which have caught the market frenzy?
Anand Shah: I would not say missed out. We have avoided and as I said, the key philosophy that we follow is identifying strong businesses which have a lot of moat, sustainable and competitive advantage and a very good path of growth. So we are continuously looking for opportunities in growth and high moat businesses. We are fully invested. We have been participating in these markets very well. This is one area because we are not able to understand the valuations at this point of time we have not participated consciously.
At the start of this interview you said one cannot get good prices and good news together. We were also discussing how this is perhaps not the time to be greedy. In a sense does that also mean it is going to become the return of the cyclicals a safer bet?
We are in an economy, which is healing not only from the Covid-1 and Covid-2 wave shocks but also demonetisation, GST implementation led disruption or the NBFC crisis led consumption slowdown — almost four to five years of disruption and slowdown. Given that a huge fiscal stimulus has come through last year and this year we feel fairly confident that the economy is recovering well with the help of global China plus one strategy and with PLI related manufacturing capex coming back, the growth can be sustained for a while.
When there is good news, maybe the valuations are a challenge, one needs to look through them. Valuation problem is a lesser problem to have than a business problem. I think the economy of me and my team is looking good, businesses can do well, the environment is right; within that, it’s the job of me and my team to identify stocks that are reasonably priced. So, while there is an issue of valuations in pocket of the markets, we have been evaluating or avoiding the cyclicals. I call it high moat manufacturing businesses. Even within manufacturing, you can have companies with very strong franchises and strong sustainable competitive advantage.
We are looking at steel and textiles being two sectors where India has a right to win and we have leading companies in these sectors in our portfolio where the valuations are reasonable. So as I said, there is good news at the macro level and to that extent we have valuations issue at the micro level but that is when the expertise of looking deep into various sectors, identifying companies and finding out something which is having good growth prospects, have sustainable growth prospects and at the same time are reasonably priced comes in. I think we have been able to do it so far.
Do we need to raise a lot of cash and find new ideas in the market? That is not a problem today, we are finding enough and more ideas to participate in this healing economy.