Markets have turned, we are getting into a broad-based rally: Dipan Mehta

If 5-7 stocks are taking Nifty up, then so be it. You can’t ignore Nifty.

If stock prices are doing well, an economic recovery is perhaps a few months down the line. When markets are turning, if you feel the next 12 months’ trajectory for the Nifty, Sensex is great, then it is the tier II, tier III which will outperform the tier I stocks, says Dipan Mehta, Founder & Director, Elixir Equities. Excerpts from an interview with ETNOW.

Is it true that Nifty is 500 points away from an all-time high, the market breadth has stabilised, FIIs have stopped selling and finally HNIs have also started buying?
What can I say, acche din aa gaye (good days are here).

But are good days really here or is this momentary rise, not a rally?
Stock markets are lead indicators and if stock prices are doing well, an economic recovery is perhaps a few months down the line. By and large, there are cycles and this particular base cycle seems to be over and going forward, if there is no incremental bad news and in the financial front, there are no blow outs as far as fresh slippages are concerned, gradually the economy will start improving and that will get reflected in stock prices as well.


The corporate tax cut has been a game changer and it is now pretty evident in the earnings which are coming through. You may keep on arguing that PBT profits are same but at the PAT levels, the earnings per share which is the most important data point for analysts for valuation those are improving significantly even where companies have been reporting flat to negative growth rates.

Yes, margins have gone higher, cash flows have improved and corporate can now start spending.
Absolutely yes. All these factors put together give a lot of confidence and in any case, there was always money waiting on the sidelines globally as well as in India. It just needed the right tipping point and that came with the September 20th announcements. The markets have clearly turned.

The challenge is Nifty has been fooling us. We may be up 10-11% over last one year, but it has all been about the 5-6-7 stocks. If you bought those stocks, it is great. But crowded trades are seldom over-owned trades. Should we stop looking at the Nifty for now?
You can do that at your own pedal. Fact is that we all benchmark ourselves to the Nifty. Mutual funds, fund managers look at the Nifty. It is a major global index and if it is going up and those five stocks are taking it up, then so be it, you cannot argue against that. But I do feel that we are getting into a more broad-based rally. Across-the-board sectors are starting to do better, take cement for example. Now auto, auto ancillary has also turned around. So by and large we are getting the rhythm back in the market. Of course, there is still a concentration of trade in the good quality 10-15 stocks, but it is percolating to the rest of the market and this trend will only gather more.
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Everybody knows that those 15 stocks are expensive but nobody wants to touch the tier II, tier III stocks because of various uncertainties -- earnings balance sheet, corporate governance, whatever. But incremental flows will find their way into the tier II, tier III stocks and the gap which has been widening, has started narrowing already and this trend will gather momentum.

Looking at BPCL, you want to do a bit of a double take. The government’s divestment drive has taken off. Do you think a lot more strategic stake sale is required or the fact that they are even have got this on their priority list is a major positive?
It is a reform process and the market thinks that it is the beginning of a major reform process as far as PSUs are concerned. The problem with the PSUs is that there is excessive control by the government over the PSUs and these are in businesses where they should not be. Because of whatever reasons, they are not as efficient as the private sector and if a disinvestment like BPCL goes through successfully and the political fallout is manageable, then it will embolden the government to do more such disinvestments. In order to do that, they will have to first clean up the PSUs as far as control, corporate governance, efficiency, all these factors are concerned, make them attractive for the foreign or local investors who want to look into it.

The whole process is a very powerful investment theme and many investors will like to ride on it. Also what favours PSU is low valuation, businesses are great businesses in terms of monopolies. Balance sheet wise, they are all excellent, at least the listed ones and they have very high return ratio. They are great businesses in the wrong hands and if those hands are changing, or if there is a subtle change in the way as those PSUs are being managed, then there is a great scope for PSUs to rally even further from this side.

The classic, the best stocks to buy are the ones where we see earnings increasing and the PE is expanding and that is possible in the PSUs where the earnings also move up and the PE multiples kind of shoot up.
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While Air India, BPCL are very large disinvestments and some of them are of strategic importance, do you think government will be easily able to slip a Concor or BHEL out?
It should be, let us see how this plays out. Right now, it is all up in the air. Let one disinvestment get done in the right spirit because in the past government has tended to sell its own stake from one PSU to another.

… ONGC, HPCL or PFC and REC…
It is an evolving situation and if it happens in true earnest, we have to see what is the political fallout. But just to start buying stocks based on the idea that they will eventually get disinvested, is like taking a punt. It may work out, you may take a small exposure to it but the likes of BHEL or even BPCL for that matter can never be part of the absolute core holding.
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The top five holdings cannot be these companies because we have seen in the past that the government goes back on its entire plan of disinvestment and then these stocks end up going nowhere like a BHEL. I do not know what is the scope in terms of earnings growth and other factors we value it on, but if you disinvest it, then the new player who comes in will sell the land, will reorganise the business, focus on the right products and turn around the company and extract its full value which the government cannot do.

Also keep in mind that the PSUs have got very strong labour unions as well. How that plays out also is extremely important. It is early days as far as India’s strategic disinvestment programme is concerned. Let us see how it plays out that is what I should say.

What do you make of the move in auto names post the festive season? Double digit sales growth that has come in, strong commentary from the likes of Anand Mahindra. Can we say that they are safely out of danger zone or would you attribute this purely to festive demand?
The turnaround in auto was long overdue and it is great that we are seeing these kind of pickup, especially in the festive season. Most analysts and industry observers say let us see what happens in November, December or so.

The advantage in auto is that we get quality data month after month and we are getting even registration data these days, although that is not as accurate. As an investor in auto industry, I would like to see a few more months of double digit growth rates, see how that is playing out before deciding on the increasing exposure to auto.

But I tell you one thing I am not happy with is the long-term trajectory of the auto industry. It is not a sector which is going to be a market favourite over three-four years or so. The reasons are partly structural, partly comparative intensity, partly disruption which is taking place within the sector.

I would be very careful to play the auto shares going forward. They are great trading bets because they had been oversold, under owned and now you have some positive news flow, so you will quickly have that upswing. But can they scale to their previous highs and give returns from that on a consistent secular basis? I am not so sure.

Lot of funds have bought into NTPC of late. It is one of the top holdings of Prashant Jain and one of the top holdings of S Naren. Their logic is utilities do well when interest rates are declining and frankly except for NTPC and the Adanis a little bit, no large corporate group has added a lot of power capacity. Is there money to be made in a stock like NTPC which frankly for the last couple of years has been a dog of a stock?
Not the last couple of years. Since listing, it has been a huge underperformer and when the markets are down, you want to go for value plays. Price to book is great, dividend yield is fantastic, you get steady cash flows all that is fine but what makes money in the stock market is growth and that is missing as far as utilities companies are concerned.

By and large, there is a fine balance between installed capacity and demand at least at the price point at which we are just now. The monthly figures for electricity generation and consumption are not showing double digit growth and if you want to make money in the market, you have to find businesses which grow at least 15-16% at a reasonable valuation. That particular assumption has not changed.

You could have trading rallies in the likes of NTPC or some of the other slow growth PSU companies and that is what it is. In one year, it may give you 15-20%, even 30% return, but then for the next five years, it may remain at the same level, whereas other growth stocks may become multibaggers.

What is your view on Yes Bank?
We had fantastic results from Axis Bank and ICICI Bank. If you go back two-three years ago, Axis and ICICI had corrected 45% from their peak. They are in a similar situation where IndusInd and RBL are just now. Yes Bank is in slightly deeper mess than these two banks but if Axis and Yes Bank can come around from the problem they were in, providing for all the NPAs, cleaning up the balance sheet, raising capital and are now on a solid growth path, then the same can get repeated in IndusInd Bank or an RBL and maybe even YES Bank as well.

In investment, we do not want to buy the best bank but best investment opportunities are where there is stress just now, valuations are cheap, there is uncertainty as far as their slippages are concerned.

Survival?
Survival also but if they live through these tough times, then these stocks can give you 35-40% compounded return over the next two-three years or so. Banking is a great business to be in in India.

Demand will never be a problem. It is a credit-starved country.
Exactly. When you have a situation like this, I would like to put the stressed-out banks on my radar and look for opportunities over there. I would watch them closely, see how they are turning around, see how they are playing out and maybe get higher returns in the likes of Axis, ICICI, HDFC or Kotak. When markets are turning, if you feel the next 12 months’ trajectory for the Nifty, Sensex is great, then it is the tier II, tier III which will outperform the tier I stocks.

Given that we are talking about some of the PSU names now, would you look at specific names like SBI that has also delivered?
SBI came up with a great set of numbers and ironically these days the PSU banks have better provision coverage ratio than the private sector banks and it does seem that now maybe the likes of SBI and some of the larger banks can provide some amount of consistent growth going forward. Again there is scope over here for the valuation ratios to improve the price to earnings or price to book or so.

I would say that one should not be negative on likes of SBI or some of the larger stronger PSU banks as they have scope to deliver good returns. They will have some amount of volatility in the earnings, but the overall move maybe quite positive going forward.

Last time we spoke you said you were preparing a portfolio for the bull market, stocks where you can get 40-50% return in the next two years and so that when the bear market comes, my 50 becomes 25 and yet I get a CAGR of 25%. What are you trying to buy in that?
As I said that the focus is more on the second level players over there. In banking, we are looking at IndusInd Bank, RBL. In NBFC space, something like an L&T Finance is looking quite interesting, being available at reasonable valuations. That is another sector we are looking at.

And then across the board, within the consumption space -- appliances, FMCG to an extent. Within FMCG, I am looking at the likes of Jyothy Laboratories or Godrej Consumer which have underperformed HUL or Nestle. That is the theme that we are trying to follow through and depending on how the results are and how this particular rally shapes up, you will get better returns in the second level stocks than the stocks which have been outperforming so far. So you could see a turnaround over there.

Would you trade out of a Nestle if you own it or a D-Mart or Bajaj Finance purely because they are expensive or would you like to keep it simple. You may not make money in six months but you will also not lose a lot of money?
It is a difficult one to answer and the way are going to approach it is incremental flows. The incremental flows come from households, it comes investors cash flows. Incremental flows are not in the Nestles and the Bajaj Finances and HDFC Bank. Incremental flows are in riskier bets and gradually if you have 70-80% in the safer stocks and if you move that ratio lower through incremental flows to 40-50% or so, over the next two years, you would have a nice outperforming portfolio with certain amount of stability. Whenever downturns come, the top holdings will remain quite solid over there.

Insurance has been a sector that has been growing very steadily, More opportunities here?
We like the insurance sector. And I will give you a stock with usual disclosure that we and our clients are invested in. We like ICICI Lombard in the general insurance space. It is India’s largest private sector insurer and if you want to buy a private insurance company, this is the only standalone listed company, the rest are all part of holding companies like a Kotak or a Bajaj Finserv or so.

So we are very positive over there and this is a great secular growth story. It will gain market share at the expense of PSU banks and what we like best is that this company focuses on profitable business. In crop insurance, it does not get the right yields. It exited out of it completely at the expense of losing out on large revenue. But it is very focussed, well managed and it is a great business.

If you are not bullish on autos, why are you bullish on ICICI Lombard because a large of their insurance is actually autos?
That is a bit of misconception over there. Not only do they insure new vehicles but the older vehicles also need to be insured and there are changes in the Motor Vehicle Act which benefits insurance companies. And now they are moving more into even mediclaim and general insurance, fire insurance. So, it is a completely diversified company and it can have a solid growth going forward, at least maintain its 15-20% type of top line, bottom line growth. It is an expensive stock, around 50 times or so, trailing 12 months. But it is a steady one and we do feel that it can give good returns going forward.
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