There is a whole lot of passive-isation happening in the largecap space, Manish Sonthalia, Chief Investment 67552154
Officer and the Director of the India Zen Fund, Motilal Oswal AM-PMS, tells ET Now.Edited excerpts:How are you dealing with the market volatility? On one side, there is the promise that good companies will make a comeback but on the other side, there is serious price erosion in Eicher, Page Industries or Asian Paints. You focus on quality at reasonable price, but that theme is getting challenged.There are no shortcuts and you do not change your strategies when the mood of the market changes. It is as simple as that. The long-term trajectory on earnings on these companies remain perfectly intact if you are not seeing a major sector rotation like the capex cycle picking up. The valuations are not going to fall because there is simply too much of capital to be deployed.When stocks are cheap, they are cheap for a reason and we have seen many of these names lose 70%, 80%, 90% of the market cap on the garb of them being cheap. It is better to buy quality provided you understand the business and the free cash flow generation ability on these businesses for long periods of time. One will have to live through the volatility and I do not think changing strategies really work. There was a disruptive change in a company like Eicher a year and a half ago and business slowed down. If a quality company which has got excellent cash flow also corrects by 30-35%, it just makes you wonder!The whole point is that if the stock has gone up from say Rs 300-400 to Rs 32,000 and it has come down to Rs 20,000, now the valuations are 20 times one year forward numbers. All these years, the valuations were 40 times, 50 times one year forward numbers. The move from Rs 500 to Rs 20,000 has got established and of course it went to Rs 32,000 and has come down to Rs 20,000, but is it cast in stone that the volumes are never going to cross 60,000? I would not believe so. 9,25,000 guidance obviously is due to reasons like insurance hikes, ABS and BS transition and these would have an impact on the cost price and that is having an impact on their demand. Of course, these would be temporary. You have a very strong marriage season this year and UP is one of the very big new markets for Eicher which is coming in. I would tend to believe that even if you see a de-growth for Eicher this year, if we look at FY21, a 15% type volume growth is very much doable, without taking into perspective anything on the export front.Nothing really is happening on the export front and so valuations have come down. The stock has now moved from Rs 500 to Rs 20,000. At 20 times one year forward numbers, you cannot really argue that the valuations are expensive. During the journey from Rs 500 to Rs 20,000, it appeared the valuations were very expensive. It went to Rs 32,000 and that is why it has seen a correction of 35%.But from here on, if the 15% growth comes through, then you will see a slow and steady upmove in Eicher. You would require six months of timeframe to gauge whether a product has really succeeded or failed. The initial euphoria is always there when a new product is launched. For shorter-term investors, it is really a game of patience. Why would you put your money into Eicher? What is the timeframe when you see that a meaningful growth visibility would come back for Eicher because right now clearly that is a miss?There is nothing called short-term investing. It is always short-term trading. Let us assume that somebody is looking at the next one and a half to two years. Even buying at these prices should make you money in these levels but if anything very significantly different can happen between now and the next six months, a lot of it will be dependent on how this whole money into the rural parts of the economy flows through because we are looking at an election year. All these things are ifs and buts for the short term. But definitely once all these transition measures are taken, it is not that the journey for motorcycles in terms of volume growth is over. Of course 11-12% volume growth over the last decade will weigh down to something like 7% odd and within that, the 350 CC plus segment definitely has some room. Of course, there is going to be increased competition but it is an evolving story. I would not believe that Eicher is done with. It is just a stop in a long journey ahead for us but there are no shortcuts for the next six, nine months. If one wants to fillip through for the next six-nine months, he or she may be free to do so. You can get out but nobody is going to tell you when to get in and you will only realise that in hindsight that the price would have moved up and you would have exited at a lower price.Are you saying that there will be no margin hit on fuel sales for oil marketing companies. What is your view largely on the oil and gas sector?They are making some very decent margins on the marketing side now. But this Re 1 cess absorption or Re 1 duty absorption has taken the faith away from all oil marketing companies. In terms of PE re-rating, the amount of market capitalisation loss that one has seen in the oil and gas sector is not funny. It is just Re 1 and that too for a few days and that has eroded close to Rs 2 lakh crore worth of market from the state owned oil marketing companies. Of course coming to fundamentals, there is deep value. There is no doubt about it. You are trading at valuations of one time price to book and maybe three, four, five, at best six times price to earnings depending on how much of inventory losses come through on account of the crude correction as well as the forex impact. I would tend to believe that companies like HPCL, etc, would make something between 5500 odd crores, everything said and done for the next three years at least and then you are looking at a capex for all the oil marketing companies. Net-net. I would want to believe that there is some very deep value in oil marketing companies but sentiments have got soured purely on account of PE de-rating and it would take some time for the PE to re-rate.Also there has to be an assurance coming from the government side on this front because investors do not want to believe this whole confusion about decontrol and control, just because of that Re 1 duty absorption that was forced on OMCs for a couple of days. Then oil really tanked and they are now making some supernormal margins on the marketing side but the damage has been done. Fundamentals are perfectly intact.What about financials? The general consensus is that you should now buy corporate banks as they have CASA, money to lend. Retail banks are expensive, consumer is slowing down and NPA delinquency will start. Would you buy corporate banks?I believe this and in fact we have bought ICICI Bank. We have taken money off Bajaj Finance. This is an environment where banks will be at an advantage over non-banking finance companies and you are right when you are saying the retail focussed banks have really done very well over the last few years. They may go through time correction. There is nothing wrong with that but even for the corporate banks that we talk about –Axis and ICICI Bank — 40-50% of their book is still retail. I firmly believe that the corporate NPA cycle has peaked and valuations are 1.5 times price to book for ICICI Bank. Remember. they have some invaluable subsidiaries with them; the life insurance business of ICICI or the general insurance business of ICICI Bank. Insurance is an infinite ROA business. You require capital for a period of 10 years and after that it is free cash flow machine forever. If core banking book starts to revive, and you are getting at 1.5 times price to book, it is certainly better than a Bajaj Finance at six times price to book where 40% growth will not come. Bajaj Finance management are guiding 20-25% growth rate and for that to pay a six times price to book and a 40 PE seems slightly out of sync. So, there is definitely a case for corporate banks. We have incorporated one of them in our portfolio.There was a bit of a macro risk in 2018. Only select largecaps managed to outperform. Now that macro fears have receded, how do you think the general mood will change?2019 is going to be an year of the emerging markets. Everybody is fixated on a growth in a trade war environment between US and China. The US Fed is now starting to sound very dovish and no balance sheet shrinkage seems to be coming in from the European Union. With WPI and CPI numbers well below the RBI trajectory, we are looking at a rate cut situation rather than a rate rise situation. The interest rates cycle for the moment may look slightly toppish and in that sort of an environment, money flows from developed markets to emerging markets. Emerging markets are to be bought when there is chaos all around and there is chaos around all emerging markets in 2018. One would have to figure out who has fallen more. In this sort of an environment when so much of domestic capital has flown into the largecap space and so much of domestic capital has been taken out of the mid and smallcap space, if one is talking about a revival in corporate profits — 50% of corporate profits is represented through Nifty50 stocks but the balance 50% is represented through the broader markets and they have seen a massive correction. The small cap index itself is down some 30% for 2018. That sort of cut with the earnings cycle reviving would want me to believe that there is more money on the table in the case of mid and smallcaps as opposed to the largecaps because the latter will give 9-10-11-12% type of returns and everything has been priced in for the next one or two years.There is nothing called cheap in the markets in the largecap space — be it consumer, private banks, or metals space. But there is value across the table in the mid and the smallcap space. One only needs courage to put money out here but there is greater comfort in mind when it comes to largecap investing and not so much so in case of mid and small cap investing. There is a whole lot of passive-isation that is happening in the largecap space. If that be the case, then how is one supposed to generate an alpha? It will come in the mid and the smallcap space so that is the area to focus on in 2019.
from Economic Times http://bit.ly/2RLQl3b