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Problems at PSU banks wont go away in a hurry

Blog Blog Details
  • May 21, 2018
  • Mr. Manish Sonthalia|
  • Director & CIO - India Zen Fund and Head - Equities, PMS

Manish Sonthalia of Motilal Oswal Asset Management says rising interest rates, inflation and higher valuations are leading to losses in the market. Edited excerpts:

You have kept your faith on midcaps and have been saying that in this decline you have been looking out for good ideas as well. Is there some sort of a leverage play that is leading to accentuated decline. Look at a stock like NCC. It has suddenly collapsed 10%. What do you make of these 10-15% kind of cuts that we have seen in the last few weeks?

It has got to do with valuations and nothing else. If you look at the numbers by and large they have been coming through, but in a rising interest rate scenario, it plays on valuations immensely and if the company is reporting a 15% earnings growth, you can’t have that company trading at a 50 price to earnings multiple. This becomes accentuated when you see a CPI number just a last evening on higher print than that was expected. So I think it has got to do with interest rates, it has got to do with inflation, and it has to do only with valuations. By and large I think it has been a fair quarter as far as the earning seasons is concerned both on the largecap as well as on the midcaps side. 

One point which lot of people are making is that last year was a cost of capital rally in the midcaps and this year that is turning on its head. You think from mutual fund investors point of view is the year to get into largecap perhaps Nifty ETFs or lagecap funds?

The previous time we crossed 11,200 or just approached 11,200 on the Nifty and from that point you have seen the midcaps and the smallcaps correct by 20-50%. Now we are again approaching those levels of 11,200 on the Nifty, but the midcaps have really not risen that much. So I think valuations correction is ongoing for the last couple of month. In fact, the incremental money that has been coming in funds and PMS is all going towards largecap funds. So, you are going to create the same excessed in largecap stocks that was done when the markets were rallying one way from let us say 10,000 to 11,200 and it was the midcaps which were participating all along.

Now this time around the incremental money is again chasing the largecap, so it is never an easy game to make money in stock and if you chase momentum on either largecaps or midcaps there will come a point in time when your strategy is not going to work. At the end of the day it is got to be the price that you are paying for the growth that you are getting.

I am simply looking at price performance and seeing where all the cuts have been for instance a stock like Jet Airways is down about 30% in one month, we have seen plenty of pain in a couple of cases where earnings have not been up to expectations. So when you are hunting around for midcaps bargains now in this environment, what specifically is exciting you?

Some of the sectors which have actually delivered a number are the consumer staple names across the board. There even if you have let us say slightly higher valuations they seem to stick in terms of pricing or let us say the IT names they seem to stick.

But I think the pharmacompanies are yet to report the numbers. If they report some decent numbers, I don’t think that the prices are going to correct every significantly that the correction has already happened in most of these names or let us say the GST plays. If there is a shift from unorganized to organized, I mean these are some of the spaces where you will find comfort. But of course if the numbers are not there and the valuations are high, obviously there is no respite. I mean it is going to fall like a vertical knife.

The other point which is being discussed is whether this year is going to be one such in which we are going to see more money move out of banks and NBFCs? We have already seen from the top that weight is down of financial in the Index, but do you think it needs more correction?

If you see the incremental data coming out of the financial space, the incremental market share for private sector banks and NBFC is more than 100%. It means the deleveraging that is happening with the PSU banks all of that growth is going to the private sector banks and NBFCs, so even if they are expensive the bigger private sector banks which has decent NPLs, or they don’t have NPLs out of control they would just tend to price in future growth and you keep on discounting future profits currently. Maybe you were discounting two years of growth now maybe you will be discounting three – four years of growth because problems of the PSU banks are not going to go away in the hurry. 

So, from that point of view, I think this private sector banks and NBFCs space is going to remain in limelight in a positive way. But at the same time the cost of funds is actually going to increase for NBFCs and that is going to weigh against the valuations at which many of the NBFCs are actually trading. 

So, it is slightly adverse for NBFCs, but very positive for the private sector banks which have decent CASA ratios and a decent lending book that they have.

You have liked midcap pharma a lot and correct me if I am wrong you have pared down your stake on some of the oil marketing companies. I think HPCL was a large holding but that has been pared down. Soon PMCs first up with this $78 price of oil what would your current positioning be?

If you would have followed the news they have raised prices on petrol and diesel just a couple of days back and they had not been raising prices over the last 15 days, so there was an apprehension whether actually deregulation is working or not working. Now with the increase in oil prices, the prices of diesel and petrol there is at least a comfort and belief that of course if the crude oil prices are heading up or if the rupee is depreciating and they need to take let us say Rs. 2 of hike to reach normalized margins that they were having 15 days ago then actually that mechanism is working.

So, from that point of view the valuations on all of these OMCs are actually very good. There was excesses when you had the prices of let us say an HPCL closure to Rs 550 or thereabout but as these single digit prices to earnings multiples and if these companies earn normalised margins with a 5-6% volume growth I don’t see how the prices can correct significantly from these levels. So, I definitely find hard core value in the oil marketing companies at these prices and from that point of view at least 4-5% allocation is good. I don’t see how you can lose money buying them on these prices.

On pharma since you are saying that there is very good value from a two to three year perspective what kind of pharma companies would you look at now? Would you look at the large direct plays on the US market? Would you look at specific contract research and manufacturing services (CRAMS), active pharmaceutical ingredient (API). How do you play pharma?

You can look at pure domestic formulation companies, you can look at generic companies having specialty pipelines and you can look at CRAMS. All of them have deep value and depends on what valuation are paying for what growth. I think there is value across table.

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