How do you see things building up particularly as it is also the expiry week? We have been seeing that trend toward consolidation weakening today for sure?
In terms of the last two-three months, the move has been pretty sharp from a 30% to 50% up move in different indices. So today’s correction may be just part of that profit booking journey from a market point of view. Even though it has been a broad-based correction today and none of the sector has been spared today, even the likes of FMCG with HUL, Nestle have also corrected 2-3-4% today.
So from that point, one needs to see next week what is going to happen but the market is incrementally getting worried as to in terms of the incremental Covid cases have not been coming down. From India point of view, they have stabilised at 90,000-95,000 on a daily basis even though recovery is pretty sharp from that point. I would see this correction as a part of that profit-booking exercise on an overall basis. We continue to be positive on the market and these corrections in our view would be bought into by people who are on the sidelines.
What is the fundamental reason for this market to go higher from here?Why can’t they fall more, why can’t they go down by 10-15% because the valuation comfort for the market, the earnings trajectory for the market is nowhere close to the comfort zone?
If you see what are the macro indicators indicating, companies sales will recover with a lag but one keeps on looking at what the high frequency data point is indicating. Look at the toll traffic numbers. They have already crossed 85%. Petrol consumption has started becoming positive on YoY basis. You look at different data points. Most of the corporate truck financiers mentioned that 85-90% of the vehicles they finance are on road.
Broadly the sense you get is on an entirety basis. Most of the sectors are back to 80-90% on a normal run rate basis. There will be some sectors which are lesser than that. For example, today I was reading an article wherein footfalls in malls have crossed around 50% of what the normal run rate is and sales have reached 60-65%. There will be different sectors which will recover at different points of time. But the market correction was led by fear in people’s mind and as and when the fear recedes, you will see activity in different sectors come back slowly and steadily.
We go to the office. Look at the traffic on the road. The fear has come down drastically in people’s mind because people are taking heart from the recovery rate. India has crossed the 80% recovery rate. Now it is well understood that one might contract Covid but the recovery chances are very high. From that point of view, the fear coming down in people’s mind alone will lead to different pickups at different points of time and the market on an overall basis, in the last three-four months, has clearly divided in terms of sectors and stocks which are Covid winners and sectors and stocks who are Covid losers.
So you have seen the first big up move happening more in the Covid winner sector — be it pharma, IT or the essential part of the market. But the Covid loser sector is where you have not seen recovery in full form. Banking being a classic example. Banking forms 30% of the index. I think on an overall Nifty headline basis, the next big move would happen in terms of Covid loser sectors and stocks. That is where the valuation is much more on the side and money used to be made on that part of the market. If you take the next six months, till March the Covid loser sector will do better than the winner sector from that point.
Going by that logic would you say buy this dip in pharmaceuticals?
The healthcare index is 50-55% on a one-year basis. We have seen a fair bit of earnings upgrade happening for stocks in the entire sector plus you have seen a rerating happen in the sector. Pharma remains an evergreen sector where there are different models at play. So from a longevity point of view, they will continue to give returns. But if I have to pick a sector in the next one year, I would place my bet on a sector which has lost out to Covid. Pharma has been more a winner sector from that point of view because when things improve in terms of recovery, money will equally flow out of Covid winner sectors to Covid loser sector. A correction of 3-4-5% does not make the sector very attractive when the sector has gone up 50% in the last 12 months.
I will probably nibble at private sector banks where the narrative has been bad but that is the reason we will be getting stocks of the top three-four private sector banks at very attractive valuations. That is where bigger money will be made over the next 12 months.
Where within private banks would you recommend buying? Is it going to be the bottom-up stories or would you say stick to the top 3-5 names?
One realises how difficult it is to build a liability franchise. The first metric I would look for is to buy a private sector bank which has a good liability franchise and where the cost of deposit is on the lower side.
Second point obviously is that in the entire pandemic, different banks coming out of the crisis will be very different. You have to choose a bank which has a very healthy capital position because incrementally as the economy reflates, you will need the banking sector to lend money and so the top three, four private sector banks are in a very comfortable tier-1 ratio being like 15-20%. They will be in a very healthy position to lend as and when things come back to normal. So at this juncture, I will probably not go beyond the top four private sector banks in case I put money in the banking space.
“The top four private sector banks would be stocks I would play in the sector because these will be the survivors of a bad cycle and will make merry in the next one, two, three years as and when normalcy returns.”
Also, some of these private sector banks are available at closer to one time price to book. So you have the comfort of the valuation side in these banks even though one does not know how the book will behave because people are still very afraid as to what the delinquency level will be out of the current book.
But having said that, the top four private sector banks would be in a reasonable position from a balance sheet point of view and also from a P&L point of view. A lot of these banks, especially the top ones have a healthy contribution coming from the subsidiaries. So take ICICI Bank or Kotak Bank. About 30-40% of value comes from subsidiaries which are doing very well — be it the life, general insurance or the AMC business. That would hold these banks in good stead in case there is further trouble going ahead from that point. So to cut the long story short, the top four private sector banks would be stocks I would play in the sector because these will be the survivors of a bad cycle and will make merry in the next one, two, three years as and when things come back perfectly to normalcy.
For a sector where institutional investors are talking about value and a bet on India, it is a sector which in a rising market gains the least and in a falling market, the first to fall. Has structural damage happened to banking which we are not realising today?
Two kinds of damages can happen; one is obviously structural, the other is cyclical. If we take the top banks in country, especially the private sector banks, the damage to accrue to them would be more cyclical than structural because if we look at the top banks — HDFC Bank, ICICI Bank — their PPOP is more than 5-6%.
Right now, their moratorium book is around 10-12%. Even if 40-50% of that goes bad, one would see a maximum of 5-6% slippage. The LGDs will obviously be not more than 50-60% across. I do not see more than 3-4% of the book ultimately as loss for these top three, four private sector banks. Probably HDFC Bank is in its six months of profit or nine months of profit from that point of view. So it will be more a one year phenomenon in terms of the overall damage the banks have to take on their books and how one needs to see all these banks.
For example, suppose in case of HDFC Bank, the market cap prior to correction was Rs 7 lakh crore, currently it is Rs 5 lakh crore. So, HDFC Bank has aken a Rs 2 lakh crore knock. But from an intrinsic value point, HDFC Bank makes Rs 25,000 crore profit. So maybe, HDFC Bank will not make for one year, does that mean the intrinsic value comes down by Rs 2 lakh crore? The answer is clear no.
So to cut the long story short, it is a one-year damage to the P&L that these banks will go through and it would not be a balance sheet damage for these, especially the top three, four banks. I am sure that the book value for these banks at the end of FY21 will be higher than the book value at the end of FY20 so there would not be any net worth dilution from that point of view from a banking system point of view.
What would you be buying in pharma? It is not a good idea to talk about pharma as a category because unlike private sector banks which work together, pharma does not work together.
I cannot comment on stocks but there are different business models in pharma; one is more the domestic focussed pharma companies like Abbot, Torrent Pharma. There, it is proxy to consumption because you see the IPM growing by 10% and these good companies are growing by 10-12% and the margins these companies make is somewhere between 25-40% and their free cash flow is also very high in this business because the capex intensity is very less. The domestic focussed pharma names are very good compounding plays. It is a very attractive space and you can treat that as similar to FMCG names. from that point of view.
The second business model is companies which are focussed more on global markets and more so the US market. Within that, the likes of Dr Reddy’s, Lupin and other names are there. We have seen at different points of time, things either improve or deteriorate in this space. If you take FY15 to FY18-19, when there were structural changes in the US market in the form of higher competition, that eroded the supernormal profitability of these companies that were seen in the past. Right now, we are seeing some normalisation in the US markets because the price erosion is now 5-6-7% and that is in the normal range. But that market you will continue to see pricing pressure. It is a very competitive market and one one needs to be very agile in case one is playing a company which is focussed more in terms of the global market and especially the US.
The third is the speciality models and companies Divi’s or Syngene or Biocon. There you need to look at different companies under different lenses. Broadly you can put the pharma names into these three buckets. In case, one has a longer term timeframe, I would put my money more in the first bucket in terms of more domestic focussed pharma names because business is very predictable and throws up a lot of free cash flow (FCF) from that point of view.
And the second and third one needs to be agile and different business models. It is a very heterogeneous sector and I cannot comment what to prefer there from that point of view.