“Till earnings decisively break out to the upside the market will find it difficult to move up,” he says, adding, no significant downside is seen either. “We are in a holding pattern where the market needs to digest its valuations,” he adds.
Prakash was sharing his outlook on the market in Samvat 2073 with CNBC-TV18, in a Diwali special series – Gods of Stocks along with fellow ace investors Manish Chokhani, Director, Enam Holdings and Raamdeo Agrawal, Vice-Chairman and Managing Director, Motilal Oswal Securities.
Speaking about his picks in the banking space, Agrawal says he prefers to position the portfolio based on underwriting quality in the banks and steer clear wherever underwriting is a suspect. “So many banks went under in 2007-08 globally. It was all because of bad underwriting.”
Chokhani quotes the golden market rule “you have to be fearful when everyone is greedy” as he discusses on non-banking finance stocks and microfinance companies. He believes it is time to be fearful because biggest mistake in capital allocation are made in the best of times and for these companies this is indeed the best of times.
They also shared their take on different sectors and specific stocks within each sector.
Below is the verbatim transcript of Manish Chokhani, Akash Prakash and Raamdeo Agrawal’s interview to Latha Venkatesh on CNBC-TV18.
Q: 2072 Samvat is behind us and we are embarking on 2073. 2072 nobody ever guessed that steel is going to be the best performing sector. So, let me start straightaway with that question. What is going to be the magical sector of 2073?
Chokhani: If only I knew I would really be the god of stocks. So, as I said we are all students. It just proved the point that whenever things are completely discarded and mispriced that is where you make the returns and reality was last year commodities in general were all beaten up and completely neglected and you have seen that play out not only in sectors but markets as well. So, Brazil and Russia has performed extremely well. Their currencies are up, their markets are up and naturally the stocks are up as well. Other than steel also Hindalco performed very well, cement has performed brilliantly, oil stocks have come back, the public sector undertaking (PSU) oil pack and all as well. So, it is just a lesson that every fruit has its season and like all of gods beautiful creatures everyone has their place in the sun at some point.
Q: Far away in that perch you would have noticed that Indian stocks have performed reasonably well over the past 12 months and even the past 24 months, valuations are now standing at 17 times and in some cases much more. What is the sense you are getting, will 2073 be the Samvat year when you realise that stocks are overpriced or do you think that growth will come and justify the numbers?
Prakash: We are still reasonably positive. You are going to catch a breath for some time here because obviously as you said valuations are not cheap and we need earnings to catch up. But hopefully given how low the base effect is in December and March of next year we will see reasonable earnings growth over the next 6-9 months in India and then that will give the market hopefully another leg or another wind of growth. But you are in a bit of a holding pattern here for some time till earnings catch up. There is very limited scope now for multiple expansion.
Specific stocks obviously will move up and down depending on specific circumstances, it is more a general call. So, till we see earnings decisively break out to the upside the market will find it difficult to move up but we don’t see significant downside either. We are in a holding pattern where the market needs to digest its valuations, it needs to digest the moment you had had till now and if and when – we think it is only a matter of when – earnings come then that will give the market the next lease of life.
Q: Steel and Brazil and Russia came out and performed practically out of nowhere in the past 10-11 months. What is the sense you are getting, what may be the undiscovered portion either market or asset class or stock or commodity for the next 12 months?
Prakash: I would answer similar to what Manish is saying that I wish I knew because if I knew then obviously I would be positioned in that particular asset class or stock whatever. So, difficult to say, it will obviously be something which is off the radar at the moment, under owned, underinvested, could be PSU stocks, could be real estate, maybe IT services, I don’t know frankly, it maybe a combination of various things. But frankly that is always easy to identify post after the event. It is almost very tough to say beforehand. So, I don’t want to hazard a guess on something where I will probably be proven to be wildly wrong.
Q: I went through what your funds have recently been doing and let me just come to the banking space. You all have always been bullish on public sector banks (PSBs), you all always had HDFC and IndusInd Bank and I have heard you speak about HDFC Bank several times. You have added Ratnakar Bank to it. Of course you have Bajaj Finance, you are one of those rich guys who had identified it when it was probably Rs 1,000 or whatever and then went on to become Rs 10,000 and among the PSUs you only have State Bank of India (SBI) if I am not mistaken. Now I don’t get this, you have some private sector, one public sector, some Non-Banking Financial Company (NBFCs). If banking and NBFC is a proxy of the economy are you convinced that there is growth or you are buying these banks for individual reason?
Agrawal: If you see for the last 12-13 years the private sector banking opportunity because of value migration from public sector to private sector it was imminent in 2000, it was imminent in 2010 and it was more so imminent today that PSBs will become much smaller size of the overall pie in 2025 or 2030. So, the migration is on right now and that is why private sector banks are doing very well and NBFCs are also proxy to private sector banking opportunity like Bajaj Finance or HDFC Limited or whatever. So, the bigger picture is like that we want to be in PSB space which is growing at 15 percent per se the industry. Now within that we have chosen to position the portfolio around the pristine underwriting quality in the banks.
Q: The best due diligence quality.
Agrawal: Yes, wherever there is a track record. So, we don’t know who does what. Almost everybody does the same thing. If you look at the front end, if you are a consumer you can’t figure out what is going wrong. But when you look at their books, how they have performed in 1-10 years what has been their track record or quality of credit underwriting because that is the core to what can happen to the bank. None of the banks are sunk because of high cost of operations or anything like that. They are sunk, all of them, purely because of bad underwriting. Whether it is global banks or anything.
So many banks went under in 2007-08 globally. It was all because of bad underwriting. So, I don’t want to go anywhere close to where I don’t think where the underwriting is a suspect, whether it is called private sector bank or whether it is called PSB. But we had old love affair with SBI, from 2002 itself. So, that continued because it is a literally the economy like 24-25 percent – that is why by a proxy we have suffered in last 3-4 years because of our 6-7 percent position we have definitely suffered but still we think that finally we will come out winner.
Q: If you are betting on the economy you have to bet on SBI?
Agrawal: Yes, that is one exception out there which we have paid the price for being there but rest all has done very well.
Q: Speaking of NBFCs people are raising money at really damn cheap rates and I don’t know about the due diligence quality of all those NBFCs, which are now able to get money cheaper than 9 percent and in India that would be a steal. Capital is coming really cheap. Do you think that sector is heading towards a bubble or can we still look for value and quality there?
Chokhani: Like he said in banking as well if you had gone back 20 years ago there were so many new bank licences were given out, very few of those players have survived and thrived. It is similar in NBFC that not only the public market, the bond market and private equity everyone has realised that the opportunity in this BFSI space is so large that led deploy capital and back people. Naturally everyone won’t make it.
There is a lot of misallocation of capital going on over there, especially in housing finance currently and like you mentioned the players raising like USD 2-3 billion of cheap debt financing over there, so it is concerning. Microfinance for example is going through a real bubble as well or a boom depending on how you look at it, so there will be shakeout at some point, but the opportunity is clearly there.
Q: When you say at some point is it sooner rather than later shake out, the shakeout and the bubble like feeling?
Chokhani: Again like Raamdeoji says it very well, in banking the first 80 percent of the money coming back is very easy. It is when the last 20 percent has to be recovered that’s where the profits are, so you need one cycle to go through. So what you are seeing for example in banking today is all the ills of previous cycle, which are coming home to roost today.
The sectors we are discussing now are NBFCs or microfinance you will know what wrong they did only 3 years later, so be careful in allocating capital when there is a boom as the golden saying in market are you have to be fearful when everyone is greedy, so it time to be fearful because biggest mistake in capital allocation are made in the best of times and for these people this is indeed the best of times.
Q: What did you glean from Axis numbers, it is a reasonably well run bank compared to the banking sector itself the pedigree and the people and yet we got fairly shocking numbers as well as a warning that from their watch list not 60 percent as they originally thought, but even more can slip into NPLs. What is the lesson for the quality of growth estimates for the next 12 months?
Prakash: The takeaway from Axis, that Axis is not that different from ICICI. There was view on the market that Axis is a much better run, much better credit quality than ICICI. I think our view has always been that they are both well run organisations, both the CEOs Shikha and Chanda very smart and capable CEOs and they are both present in pretty much similar exposure across the systems, so it never made sense to us why there was a view that Axis is a fundamentally far better credit quality than ICICI.
That is just being reflected now that Axis is catching up with the ICICI. I am not surprised I thought that their credit quality was quite similar. It was not showing it now showing up, so that doesn’t really concern me so much. It is not a big shock or surprise to me.
Q: What are you picking up in terms of the ability of the banking sector to come out of this downturn? Is it giving a sense that we are many more quarters away, probably 3-4 quarters away before we are out of the funk as far as corporate facing banks are concerned?
Prakash: For Axis Bank itself I am not that surprised. I always felt that the asset quality of Axis and ICICI and State Bank for that matter not dramatically different. They are all large well run institutions and I have great respect for both Chanda and Shikha and that both are doing very well and very qualified and very competent, so I am not surprised that Axis is catching up what ICICI has been saying as they are in the same economy, they have similar exposures, so I am not that shocked.
The market was bit disappointed, but I am not surprised and in terms of messages for the economy I think it is just showing what we all know, which is that the pain on the asset quality side is still there. I think you may have another couple of quarter pain, but I do believe both these stocks are company which are going to be interesting if you look beyond the next 2-3 quarters.
Q: Before the break Akash was explaining that the results of Axis Bank still show that the stress is over that perhaps we have about 2 quarters and maybe it would be a good time to perhaps get into corporate banks what’s your sense, are corporate facing banks over the hump?
Chokhani: I am not sitting inside Axis or ICICI, so I don’t know what the real is.
Q: But you know the economy?
Chokhani: Look the sense is in the economy there is no real credit demand coming from the corporate sectors, so I don’t whether these corporate banks will indeed look like corporate banks 4-5 years later. Also, if you get so burnt in the previous cycle do you incrementally go a lot more towards the other sectors, because you now see the HDFC Bank taking the contrarian approach of coming into corporate lending, while Axis is probably going more towards retail lending – – at some point I guess I think things will harmonise, but coming back to what you said right at the beginning of the show that things were so beaten up, neglected and hated as you usually the best time to look at them from a pricing perspective. It is like my guru Manikbhai used to say that don’t double count. The fundamental reflect the reality, now don’t say, “oh IT is doing so bad and therefore it is continue to be bad and therefore the stocks are down and therefore let’s not buy it” and I think similar case over here.
Because as Raamdeoji said in the beginning the opportunity for the whole banking space in India is very, very vast. On a USD 2 trillion economy going to USD 5 trillion clearly banking has to become much larger than what it is today and this 70 percent share of the public sector has to completely diminish over time. They are starved of capital. They are starved of talent so clearly things will move in favour of the private sector banks and if these players learn enough lessons from the previous cycle. The opportunity is really, really very vast for them, so it is certainly very interesting.
Q: What is happening is that the bad loans are blocking fresh lending both mentally and in terms of bandwidth. Let me just digress a bit and ask your views on whether a bad bank is the way out. They are people who are floating that idea and I remember Raghuram Rajan bashing up that idea, because he was so scared that assets will be transferred at non-market rates. He would rather the bankers take the decision rather than a babu, but your thought?
Chokhani: It is a very interesting concept which works out in the west and I am sure there were better governance standards over there. My suspicion in India is if you create a bad bank there will be a rush to get classify there, because lot of the entrepreneurs can get haircuts and then get their assets back from there and we don’t really have the takeout mechanisms where other players can come and takeover these assets.
In the absence of an thriving mergers and acquisitions (M&A) market while we have cleared the Essars and the Jaiprakash and some of the Anil Dhirubhai Ambani Group (ADAG) issues. I don’t think we really have a market thriving for corporate M&A of the magnitude which is envisaged over here. Two, lot of these assets are fraudulent assets, so when you put them in a bad bank are you letting someone completely off the hook and watch the resolution mechanism there.
Q: But lot of them are overpriced, are they fraudulent?
Chokhani: A lot of them are fraudulent.
Q: What would you think?
Agrawal: My sense is this entire PSU bank mess which is there it must be solved in a full package. Dirty clothes are not washed anywhere in the public, but it is done so that is fine. Now what is the plan B in a sense that what next, so you have to recap the banks. You don’t have recapitalisation plan.
Now the next thing is this is also part of recapitalisation that you want to create a bad bank. I think committees after committees who are knowledgeable like Nair Committee and all they have given complete package. I can’t understand in Delhi people think that they have appointed a committee and now they want to appraise the committee itself. They have spent 500 hours, 1000 hours and they have used their expertise and skill in recommending something and the integrity of those guys are not in doubt and now one minister or some secretary wants to reappraise the committee’s recommendation and then come out with some fragmented solutions. It is not going to work and this problem is so big it is really crucial for next 10 years.
If India to fly in a proper way with both the engines on type, you need a very strong banking system and you cannot wish away the PSU banking. We need talents. We need autonomy. We need kind of a good management. There are banks without bankers, so first you have to sort that out and then you do whatever is required this bank, bad assets whatever it takes it takes 2 percent of GDP. Just do it, be done with, have a pristine banking system that is more important right now.
Chokhani: Let me give you a stunning figure, our banking sector BFSI has at least a trillion dollars of assets. Can you guess what is the profit after tax of this entire sector it is USD 10 billion on an asset base of trillion dollars, so how do you recap a sector where profit spoon is so tiny. The central issue in India is that.
Q: Your thoughts, it is almost as if there is a jam out there and it has to be unclogged so that credit flows. What is your recipe?
Prakash: I totally agree with what Raamdeo and Manish are saying. The reality this Rs 70,000 crore number which the government is talking about for recapping the PSU banks is actually laughable. There is no question that you need a multiple of that. Whether it is 3, 4 or 5 times. I understand that there is limited political will at the moment to privatise these banks. The Prime Minister may decide that he doesn’t want to use his political capital for this which is fine, that is a political decision. He has to understand where he wants to use this capital, that is a call he has to take. But independent of that if they are not going to capitalise the PSU banks they have to give them capital. This is not a solution that – I mean it is great for us as investors that we have got NBFCs and PSU banks which are able to grow at 20-25 percent because 75 percent of your banking system the PSU banks are on incremental basis making less than 40 percent of the loans, are growing at less 10 percent, have ROEs of less than 0.5 percent. So, they have to be recapped and all the points Raamdeo and Manish talked about Naik Committe report, autonomy, talent these are all very well known, this is nothing new that I am saying or Raamdeo or Manish are saying.
Somewhere who takes the decisions of the country have to recognise that this is a big problem, this is not like Air India or something else or BSNL where you can just let it wither away. The classic model has been I don’t want to tax, I don’t want to address the political issue of privatisating, so let they just wither away, the private sector will come and take over which is what has happened in BSNL and Air India and all that stuff where they have lost market share and have become quite a minor player in the respective markets or will become minor players. That is not a solution or template which will work for the PSU banks. It is too big, too important and too critical for the economy.
So, they have got to get this bull by the horns if required to raise money or recap, they have to do it, there is no choice. You can’t run away from this and the sooner we do it the better because the reality is that while CRISIL and all have said that there is enough capacity in the market through wholesale, bond markets and private sector banks and NBFCs to fund growth that is okay for funding growth now. If you want to get back to 9-10 percent GDP growth and get the private sector capital expenditure (capex) cycle back you need the PSU banks to be able to grow and lend a 10-15 percent growth, it is not going to happen otherwise.