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value stocks: Emam’s Sridhar Sivaram on how to avoid falling in value traps

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The best way to participate in the PSU reboot is to buy a PSU bucket. “If I am a retail investor, I would buy a PSU mutual fund”., says Sridhar Sivaram, Investment Director, Enam Holdings.


In the near term, are there any key concerns that one should be monitoring? We have started to see a little bit of outflows on the back of global developments and some regional lockdowns have started once again.
Yes, near term, those are the real concerns. I was around Nagpur over the weekend and even 60-80 kms outside Nagpur, all restaurants were shut and all shopping malls were shut. This is pre-lockdown because yesterday the lockdown was supposed to start and obviously these are going to have economic impacts. So there is already some bit of impact in and around clusters where the virus cases have gone up. But that would be a short term impact. Also, one has to keep a watch on what is happening to the US bond yields and inflation.

Does your own outlook remain bullish? Are you expecting a massive rebound to come in later this year or given the possibility of some choppiness, are you looking at a slightly broader timeframe when you are thinking of pockets like infrastructure?
We remain quite bullish on the market as long as the US market, which is the mother of all markets, continues to be awash with liquidity. We just saw a $1.9-trillion stimulus. There is a talk of another stimulus for infrastructure and education. As long as that money continues to pour in, it will find its way into various asset classes and one of the most happening asset classes right now is commodities and emerging markets. We think this asset class will continue to do well and India will disproportionately benefit from this asset allocation because we have seen some issues with Latin America especially when it comes to corporate governance and government interference. People will want to invest in countries which have a stable democracy and the opportunity to invest in stock specific ideas are much more in India. So, we are quite bullish on emerging markets in general and we think that Indian markets will continue to do well as long as the US continues this easy monetary policy. We do not see this ending in 2021. Maybe, we will have to cross this wall of worry next year.

Where within commodities are you finding comfort? It is not a newly discovered theme. Would you say that a large part of the gains are already behind us or would you say that the commodity rally has more legs to go?
As far as stocks are concerned, even if these prices are maintained and one assumes that there is no further rise in commodity prices, the earnings impact on some of these companies remains quite exponential because of the way the whole operating leverage plays and the way the profitability grows. I do not think anybody is pencilling that in right now. We are all assuming that the average prices for next year will be at least 15% lower than where it is today.

For whatever reason, if these commodity prices were to sustain here, we could see massive earnings upgrades for all commodities, be it steel, be it ferrous and even for domestic cyclicals. Look at cement prices. We are quite positive on the entire basket. Obviously the starting point is last year sometime in May, June. It was really at absurd levels and they were at 0.2, 0.3 book. Some of them have rallied. We still believe that we could continue with this rally for some more time because most countries are trying to expand their balance sheets and a large part of the spending is going into infrastructure. Even for India, the finance minister has significantly increased the allocation and the same thing is happening across the world. It will result in more spending as far as infra is concerned and result in higher demand for commodities.

But is there valuation comfort in metals?
If you assume these prices, then the valuations look very cheap right now. Valuation comfort is not there only if you are assuming that the commodity prices are going to fall about 10-15% from here and that is not our base case right now.

When you are talking about value plays, does that include some of the beaten down pockets like hospitality, tourism and pockets like that or select finds in the broader markets?
Broadly, when we have looked at value as an opportunity which will outperform growth, one of the points that we have been looking at is there is a kicker for the value stocks to move up from here. In case of PSUs, there is a privatisation kicker and a dividend kicker. In many of the cases and in case of PSU banks, there is a huge earnings growth kicker.

So, if we do not find some event which will help them to improve their earnings, then we are not playing just for the sake of value. It could easily be a value trap. Many people play hospitality and some of the other sectors that got beaten down because of Covid related issues. But we are looking at sectors and stocks which have some earnings growth kicker because of certain events. It is very difficult to paint a broad brush on all value stocks, but there is a case for value right now. Even globally, even in the US, value has outperformed in the last three-four months.

What happens to financials then and in particular banks? They are the last ones to join the party. What is the big concern here?
We are quite positive on financials also and sometime in November, we turned positive even on the PSU banks. I will give the case for both of them. The concern for financials came from the fact that RBI in its initial report indicated that the increased NPA due to the virus related NPAs would be about 400-500 bps and there was a general assumption that the PSUs will have a very high number and the private sector will be substantially lesser.

As it is turning out, that number for private sector banks and even for PSUs is substantially less. Even adjusted for the NPA which are not yet reported, the restructured numbers are well under 200 bps. One of the concerns was that there was not enough data and people assumed the worst. As it is turning out, it is not as bad and the economy has bounced back fairly well. Of course, there is a second round of lockdowns and how those play out is something which time will tell. We still remain positive on the private sector banks because they have been able to weather the storm quite well.

As far as the PSUs are concerned, one of the metrics which we were looking at was pre provision profit to market cap and many of these PSUs were trading at less than one time.

Just to give a context, market cap of private sector banks trade anywhere around 10 to 15 times their pre provision profit and our assumption here is that over the last four-five years, PSU banks have provided almost 2-3% of their assets as provisions. So the provisions have been 2-3% for the last three to four years. We do see normalisation in this the first part of normalisation will come in 2021-22 and we will see the credit cost falling from here on. Even a 100 bps credit cost fall will have a massive impact as far as earnings are concerned. We are positive on the banks but not on the NBFCs. There are some plays on NBFCs also but the risk reward is so favourable for banks that I do not need to look at anything outside this.

How are you participating in the PSU reboot? Some are liking metals, some are liking defence PSUs, some are liking the ones which are on the block for strategic sale. What is the best way to pick your spots?
The best way is to buy a basket. Obviously, the names for which the privatisation is going to happen is already out. We know that many more will be announced based on what we heard from the finance minister in the Budget speech and many announcements that have been made later. If I am a retail investor, I would buy a PSU mutual fund.

As an institutional investor, we do stock picking and buy stocks within the basket where there is a business case because we also have to assume that if privatisation does not happen, then what? You are basically trying to buy companies which do not have business models of their own and valuations are anyway in favour of PSU banks. But our assumption is that the government is pushed to the wall. There are not enough divestment opportunities available.

In fact, we had done a calculation that if the government were to divest all the PSUs up to 50%, they can recover only about Rs 1,20,000 crore against the PSU divestment target of about Rs 1,75,000 crore. So they are basically pushed to the wall. This whole process of selling small portions of PSUs has run its course and the only way out for the government is to privatise. We have seen in the past that when the government is pushed to the wall, they end up coming up with reform measures and same is the case this time. We are quite confident that this will go through. Look at BPCL; the sale of Numaligarh refinery, the sale of the treasury stocks all indicate that the process is on. We are keeping our fingers crossed.

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