The carnage triggered by coronavirus has finally made expensive Indian stocks slightly cheaper, a pain point many investors were repeatedly pointing out. So while some are shedding stocks like they just realised they were holding dirt, not diamonds, others are making the most of the fall. Opportunistic buyers including Sailesh Raj Bhan, deputy CIO, Nippon India Mutual Fund are embracing volatility. Confident about seeing a fresh set of winners once market recovers, Bhan is building a hybrid portfolio through a combination of growth and value stocks. In this interview with Outlook Business, he reveals where he is seeing value and shares his contrarian bets.

 

Do you believe volatility has peaked or do you see more pain ahead?

 

The near-term impact of this development (coronavirus) has created a lot of uncertainty, which has led to increased volatility. There are concerns about how businesses will operate in the next few months and foreign investors have been selling. Meanwhile, global leverage trades or ETFs, are playing a huge role in the selloff. Investors are reducing exposure to emerging markets on the back of risk aversion. The volatility might continue for some time. But we see volatility as a friend of a prepared investor rather than being worried about it. The minute everyone is clear about how the world will look in two to three months, the prices will re-adjust.

 

So, are you buying or waiting?

We are buyers in today’s market as the price is on our side. The idea is to look at attractive high-quality companies, which are available at much more reasonable prices than they were some time back. We had a bubble in so-called ‘expensive’ companies, which have now corrected by 50-60% in terms of valuation. So, they have become very attractive. We are using this volatility to create a relevant portfolio for our investors with a time horizon of one to three years.

 

What are the themes you are playing?

Interestingly, even before this correction, a large part of the Indian market was very attractively valued — stocks that hadn’t participated in the narrow rally. Those segments have further corrected and have become more attractive. For instance, select PSU and auto stocks look reasonably valued today. Some PSUs are trading at their 10 or 15-year-low average despite having businesses with strong cash flow, longevity and high dividend yield. But there is value across the board. We are looking for a combination of good growth companies, strong sustainability and reasonable prices.

 

But many stocks in the PSU space have been perennially cheap. So, are there any specific ones that you are looking at?

I believe utility companies have longevity in this space because they are semi-monopolistic businesses. They are valued at single-digit P/E multiples and have a divididend yield of 6-9%. I see a lot of value in this category along with reginers and OMCs, which have a huge cash-generating ability and high dividend yield despite being companies with heavy infrastructure. As soon as we see signs of normalcy in the economy, demand will recover and their earnings will stabilise. Plus, gas producing and distributing firms and OMCs will benefit from the fall in crude prices.

 

Are there any contrarian bets you are placing right now?

Besides PSUs, there are certain stocks that are under-owned, whose earnings have not been impacted materially by economic issues. This includes the pharma sector. It is attractively valued because of what it went through over the past few years. Then there are a lot of options in the consumer staples space, which are now trading at reasonable prices as compared to six months ago. We believe this is an interesting opportunity to look at.

 

Nippon India also houses one of the biggest pharma funds in India. Do you think this is the new safe haven?

The earnings in the pharma sector have started to improve over the past twelve months. Around 50-60% of earnings from most companies are coming from a stable domestic business that is consistently growing. These are also high cash flow generating businesses with a high return on capital. Plus, there is positive news flow from the US market, which will ease the pricing pressure that they had been facing over the past three to four years. Some of them have also undertaken effective cost-cutting measures. We believe the sector is coming off a difficult cycle and is very well poised for a recovery. It will also not see a big hit due to loss of demand or economic activity as compared to other sectors.

 

Are you betting on domestic pharma players or the ones that are big in the US generics space?

The domestic space has outperformed the US in the past two to three years. So, we have already seen some outperformance here. But the companies with exposure to the US have also stabilised and their valuations have corrected to all-time lows. Essentially, we see a lot of opportunities in both categories.

 

What about the hospitals space? Now that some of them are done with capex, is it a good time to look at them?

A lot of large companies in the hospital and healthcare space have expanded over the past three to four years. While many have deferred their non-essential surgeries due to the lockdown, we expect capacity utilisation to be higher in the next six to twelve months. In fact, it is a higher under-penetrated sector in terms of the number of beds. Thus, as the importance of healthcare increases, the need to create more capacity will also rise. So, I think these players have a huge opportunity for growth.

 

Does this optimism cover diagnostic companies as well?

This space has also been handed a positive tailwind because of the virus. A lot of Indian players have good asset-light business models in this space. As health awareness improves, diagnostic services are getting cheaper. People are also opting for routine tests and check-ups due to faster diagnosis and better treatment for chronic diseases. Just like hospitals, this is also an under-penetrated space. We will see good return ratio as income levels rise and people take good care of their health.

 

Do you think valuations in the ‘growth’ category are stretched even after the the correction? 

A lot of the growth stocks have good businesses, but they were being valued as if they won’t see any growth damage in the next ten years. This was because of weak economic activity and higher indexation. Now that they also have corrected materially, they have become attractive from a common investor’s perspective but growth businesses such as retail banking and NBFCs will slow down. Now, the market will start valuing cash flow generating companies with high dividend yield. Thus, when this crisis blows over, we will have a set of new winners along with consistent good performers. So, pharma companies with 15% earnings CAGR look good.

 

What about FMCG companies? Are there any that look attractive from growth and valuation perspective?

Only two to three companies have done really well over the past two years in this space. Others have witnessed valuation correction because execution has not been up to the mark. So, their stock prices have fallen 40-50%, which is reasonably attractive for the return on equity they generate. If growth improves in these categories, then we will see value.

 

You also mentioned about seeing value in the auto space. Are there any specific categories that you like?

Initially, we see a revival in demand in the two and four-wheeler space. With some support from the government, commercial vehicle segment will also benefit. Meanwhile, we expect passenger vehicles to do well in the next three to six months. There is also a large replacement category that will perform well. The lower cost of raw material, lower interest rates and fall in fuel prices will be the key positives. The sector has been seeing a slowdown for the past one and a half year and we saw significant deferment because of lack of credit, high insuracne cost and BS-VI transition. Hence, valuations have corrected by 50-60%, making them quite reasonable. But we are making this call from a year’s point of view since it will take time for positives to play out.

 

Financials, which were doing well the past year, have also seen an impact. What is your outlook for this sector?

The last bull market was primarily driven by financials. There was a broad-based strong sector performance over the past three years. Around 80-90% of the companies in this space were very highly valued, and it started with the NBFC boom. Then, private sector banks performed well along with financial services companies such as insurance and AMCs. Given that this sector has to bear the brunt during an economic slowdown, we will see a rise in NPAs. Only leaders in the space will be able to survive the crisis. They will possess strong CASA, high profitability and a well-diversified asset base.

 

Several travel and hospitality stocks have dropped to all-time lows. Do you see any value here?

It may take three to six months for these sectors to normalise. But they have fallen more than market average and are becoming attractive from a valuation point of view. One could look at investing in this space, but we would prefer a bit more margin of safety or a better cushion. Since there are other spaces with better opportunity, we would need a better entrey point for hotel and aviation.

 

Which stocks or sectors are you avoiding?

One needs to be careful about weaker franchises in financial services. For instance, some companies would have to grow at 15% CAGR for the next ten years as per their valuation. And even if they grow at that pace, investors will only see moderate single-digit return. So, it’s better to avoid them. Other sectors such as those related to travel have been significantly damaged due to the spread of the pandemic. We are being careful while evaluation these sectors and are looking at a higher margin of safety for them.

 

 

 

In terms of recovery, what are signs or parameters you would be looking at?

We are confident of focused government intervention. The economy has gone through a break to rekindle demand, and sector-specific stimulus could facilitate and kickstart the recovery process. Second, the benefits of lower interest rates will start playing out and that will be an advantage for auto companies. If you have attractive prices or interest rates, EMIs drop, making replacement and new acquisition of personal vehicles becomes attractive. One of the first signs of recovery will be visible here. 

 

The third important data point would be GST collection. This is a reasonable representation because there is very little lag in terms of data being reported. So, it reflects how economic activity is going to shape up. We will also keep an eye on the banking credit data, which the Reserve Bank of India has decided to release periodically.