Ahead of general elections, play the tactical piece through banks, IT and pharma and the structural piece through the consistent compounders, Saurabh Mukherjea, Founder, Marcellus Investment Managers, tells ET Now.
What should the markets be bracing for?
Several brokers have mentioned already that the fall in oil is good news for India. It is good for the fisc and for the 10-year bond yields. What I find very interesting is that the three-month commercial paper rates are not showing any great joy and my reckoning is that there is plenty of liquidity tightness in the money market which obviously has ramifications for the NBFCs and for broader car financing, house financing sector.
That suggests caution is still warranted in this whole selloff that we have had since the IL&FS debacle broke out and my reckoning is over the next 12 months, focussing on quality banks, well run high quality banks with great CASA, strong IT and pharma companies would be my tactical positioning in the portfolio. My structural positioning is buy great compounders and hold them for a long time. But for my tactical positioning, well-run banks who got strong capital buffers, strong CASA franchises are really well set for the next couple of years.
It is pretty clear that the old financing construct that NBFCs were relying upon — go to the mutual funds and get them to buy your CP — has gradually been replaced by a very different funding paradigm which suits the banks just nicely.
Are you stretching that pool beyond ICICI Bank or Axis because that seems to be getting to overcrowded zone now?
Kotak and HDFC Bank would be my default go-to place to play this strategy because you also need banks with proven track record of choosing the right credits.
It is a little difficult to look at the larger banks today and look beyond HDFC Bank and Kotak and say who else has successfully managed the credit cycle for 10-15 years. Amongst the smaller banks, conservatively run banks like City Union, like DCB Bank are also well placed. But well run banks with strong capital basis are really well placed for the next couple of years. You can see the tightness in car funding.
Your do not prefer ICICI Bank and Axis?
No. I would still stay away from ICICI, Axis. I am still not sure of their credit selection skills. Axis is going through a management change. It will be quite a comprehensive management change in Axis, We should wait and let the new management come in, let them settle down and in ICICI’s case the credit selection skills have been found wanting for a long-long time. So HDFC, Kotak, small banks if you want to look at then City Union, DCB but I think there is a pronounced funding challenge in our country and well run banks will be the beneficiaries of that funding challenge.
Why Kotak because Kotak does not have a strong liability franchise? They are borrowing at 6% CASA?
I think 35%, mid 30s CASA is a big buffer on their tier I. My belief is that the combination of the old ING franchise, the new Kotak franchise and their ability to improve the deepen the franchise should give them reasonably good funding access over the next couple of years. The tier I buffer is something to focus on because if you have a tier I buffer, if you have kept your powder dry. Over the next couple of years, you will get good opportunities to lend at very good interest rates.
IT in a sense was the go-to trade for the first half of this year. None of the IT companies reported great expansion and margins. That happened when rupee was at 74. That happened when IT companies enjoyed a dream expansion in margins because of currency.
The first thing to realise is given that most of these firms hedge their currency exposure a good year ahead, the benefits of a currency slide takes some time to materialise. The slide in the rupee has been rapid from 64 to 74 and now to 71, that I do not think the rupee slide both side is as yet showing up in the numbers. It will take a couple of quarters for that to show through. I am more convinced by the tightness in the IT job market. This is the tightest market for IT professionals I have seen for seven-eight years.
By tight, you mean there is a lack of talent availability?
There is lack of talent. There is immense demand for IT talent. Bangalore and other IT hubs like Pune and Gurgaon are seeing immense demand for IT talent which suggests strong recruitment activity. You are seeing that in university campuses as well which suggests that the IT management teams have visibility on demand which they might or might not have given you a visibility on.
Beyond that, US banks are in good shape. US banks are big buyers of Indian IT. The other element is 5G will gradually come through in the next two-three years and will be a big source of work for the Indian IT firms. There are good reasons to believe the work pipeline is solid and even rupee at 71-70. is a better place for these firms to be than a consistent rupee at 64-65 which is what they had for four years. That really kicked the wind out of the IT firms. Four years of rupee at 64-65, punched the living daylights out of these firms.
Beyond IT, you continue to like pharmaceuticals. But that I guess is a more selective approach?
Where pharma got smashed was not just the FDA issues which I think are well understood now but four years of rupee at 64. These companies are remaking American generics. They need that currency tailwind to give them a bit of a boost. Again rupee going from 64 to 71 should help them but beyond that, the worst of the FDA issues are passed. As you can see, the news flow on the FDA front is gradually abating and the firms with stronger chemistry skills like Dr Reddy’s genuinely deep chemistry skills built over 20-30 years are looking very attractive to me. The frontline IT firms like Dr Reddy’s or Cipla make a great deal of sense to look at . If you wanted to go down the market cap spectrum, well-run midcap firm like Torrent Pharma is also worth looking at.
Why Cipla? It is not India, it is not US. They are trying to position themselves as a semi regulated generic company.
There are two elements to that. First if you look at the Indian domestic data on generic demand, we have had five consecutive years of more than 10% YoY volume growth in generic demand.
This is about domestic consumption…
In domestic consumption, five consecutive years of 10% volume growth makes sense. As the lower income people get more money in their pocket, they are spending more on life saving on essential drugs. The second element to Cipla is that it is just too cheap to be. It is a firm with strong chemistry skills. The Yusuf Hamied legacy has been very strong chemistry skills. The results have been weak for two-three years, etc, etc, but domestic strengths, chemistry skills cannot be ignored.
Why not buy an Abbott or a Pfizer or Glaxo? You are betting on the fact that Indians would be consuming better medicines. There are a lot of these big MNC players which could really benefit.
Abbott is a cash machines. It makes it to my consistent compounder portfolio. It has got almost a quasi monopoly in some elements of therapeutic care, but it is a domestic play and I like it for that. It is in the consistent compounder portfolio. In Cipla or Dr Reddy’s, the underlying chemistry skills give the firms a greater ability to accelerate but as a steady compounder over the next three, four, five years, Abbott should be in there in a classy Indian portfolio.
Retail is just a suddenly emerging from the ashes given the breaking story that Jeff Bezos is looking at India.
So as long as I have been in India, I have been hearing about MNCs buying Indian retail. It is one of the staples of Indian business life. I am not so sure I would buy too many retail stocks. Whilst companies like Trent and D-Mart are spectacularly successful and clearly very well run, beyond a Trent or a D-Mart, I have not seen too many well-run retail plays in India where I am convinced they will make a return on investment.
Do you think that could be changing? The Economic Times has come out with numbers, specifics, debt, restructuring details. It seems like Jeff Bezos is coming through with a well thought out plan that could revolutionise the way retail is run in India.
I am not on the top of specifics of the future Amazon situation but if you step back and look at it more holistically, cost of capital is rising in our country. Already when cost of capital was low two-three years ago, our retailers were not able to deliver return on capital above cost of capital. As again cost of capital drifts up over the next couple of years, I am not so sure, that is a great story. That is the fundamental challenge in Indian retail. Very few guys make money in excess of their cost of capital and Trent and D-Mart stand out in the sector.
Which is that one asset owner or money manager you would bet on to be part of your constant compounder list? Will it be Motilal, HDFC or Reliance?
To be fair to our fund management community, in the PMS and AIF construct, you have seen several fund managers come out and do that. These guys have built portfolios where they are buying companies which broadly fulfil two criteria – return on capital above cost of capital for a long period of time and alongside that steady growth in the business. The success of PMS and the AIFs in doing it has been the key driver why this space has gone from almost no money five years ago to close to $40 billion of assets under management.
You are managing more money than insurance?
Yes, 0 to 40 billion in five years and in that same time, if we look at the equity mutual fund, largecap equity mutual fund track record, it has not been that much to write home about. This disconnect continues and alternative assets in India well over the next 10 years boom. I have told earlier that I reckon a decade hence, Indians will be saving around a trillion dollars a year. Every year, we will save a trillion dollar of additional financial savings and just to put that number in context, the total mutual fund equity pool today is $140 billion which we have created in the last 30 years. The opportunities are there for MFs but even more so for the alternative fund managers which is why you are seeing good talent come into the space.
As a franchise. what would you bet on or as a stock which would you bet on? Would you bet on HDFC AMC, Motilal Oswal or Reliance?
As a stock, I would say now that the Aspire Housing Finance thing has been sucked out of Motilal stock price, Motilal Oswal as a well run long-term play on savings in India does make sense. I wish the Aspire Housing Financing had never happened but it is what it is. In capital allocation decisions, we are allowed to be human but their asset management business, their broking, their wealth management business have got strong legs to benefit from the financialisation of the Indian economy.
Why not IIFL Holding or HDFC AMC or…?
So let us take it one by one. In case of IIFL Holding, they have got two NBFCs. One above and one below. My views on NBFCs are relatively well known now. In HDFC AMC’s case, almost all largecap equity MFs face a big challenge. It is a very difficult for the largecap equity MFs to generate meaningful outperformance and that constraints there the long-term growth.
How critical and how volatile do you think the market can get around December 11 when state election results come out?
There are two ways to answer the question. If there are adverse outcomes for the ruling party in Delhi, will there be a market pullback? There probably will be, given that lots of people have entered the market over the last three-four years with a political sort of mindset. But are there any long-term implications for the stock market? My answer will be an emphatic no. There is nothing in the Indian political or economic data to suggest that the identity of the party winning the elections at the centre, let alone the state elections has any great fundamental bearing on the economy. We all like the drama and I like it as much as anybody else but we have to be a fair honest about the whole thing. We have to say that neither the opinion polls nor the actual results have any long-term bearing on the stock market.
But in the short term you do sense this is going to be a volatile…?
Clearly because as we all know there is a generation of investors who have entered the market in the last three-four years with a specific political mindset.
If you look at what the markets can do ahead of the general elections, tie that in with what the global situation in 2019, what would be a larger portfolio construct with which you would want to approach markets?
There are plenty of uncertainties out there and I am not the expert who can bring it all together. The way I am simplifying it for myself is cost of capital. Uncertainty in cost of capital goes up. As cost of capital goes up, well-run banks with capital buffers do well. IT and pharma companies who are capital light do well and they benefit from any weakness in the rupee that we see and we might see going forward.
Beyond that, there are the classical compounders like Abbott Labs. You could throw in Asian Paints, Pidilite. These sort of companies do well. You are playing the tactical piece through banks, IT and pharma and you are playing the structural piece through the standard story that we have been discussing here on classical compounders, consistent compounders.