Strategic disinvestment can unleash the bull markets: Madhu Kela
I have not seen this level of wealth destruction in my 30 years in the market.
Small and midcap stocks in the last three years have been jumping in the same place. How would you describe the market?
Smaller companies and specifically companies which have debt of any nature, and where the company or the promoter has seen an abnormal amount of wealth destruction. We took top 1100 companies and we calculated how many of these companies have fallen more than 50%. You will be surprised to know 50% of top 1,100 companies have fallen more than 50% from 2018 highs and the total value destruction in these 50% companies is Rs 27 lakh crore. That’s a very, very large number. Obviously, there has been a lot of wealth destruction in the smaller and mid-sized companies.
The basic characteristic of these companies wealth destruction is a) misallocation of capital, b) wrong businesses, c) leverage. These are the three characters you will find in almost all the companies whose stocks have fallen. It is not that it is all gloom and doom, there are lots of companies which have also appreciated in this timeframe, companies which are focussed, have no debt, promoter issue and where corporate governance practices are very high. We are seeing a lot of companies even touching new highs.
But from the investor perspective, I would say there is a lot of pain in small and midcap segment and this is where someone like me is excited. A lot of companies from this fallen list are companies which are graduating, who have not been hurt but have been impacted sentimentally. The market can be divided in three parts; a), companies which have had basically no problem whole year. These are great companies but have very high valuations and would find it very difficult to make money. b), companies which are like high quality companies which have coma mein chale gaye, ab waha pe koi hope nahi hai basically (gone into coma and and there is not much hope there); c), companies in between wherein market perception is very bad but reality is not as bad as what the market is perceiving them to be. These are the companies which can go to any bracket -- they can get into investable bracket or can slip into the untouchable bracket. Now this is where there is an opportunity for an investor/
I have been here for 30 years; we have seen this period so many times in our life. This is not the time to buy something today and look at the stock after one month. Then you will only keep hearing stories of people and how people make wealth. You do not make wealth by taking one- month view. You make wealth by sticking your neck in companies or industries where you feel the prospect is going to be very bright three to five year down the line. This is where you make abnormal returns in equities.
It is fashionable to talk about bad news right now but for a change I am going to talk about the good news. Oil is benign, inflation is low, monsoon has been strong. But nobody is bothered about good macros and good valuations. Why is that?
This always happens. It is like a pendulum. It is either in the extreme left or it is on extreme right. Not long ago in January of 2018, every midcap company was trading at 20-25 times. So excesses were created in that 2017-18 period. Now, we are seeing the other extreme of excesses which are getting created and this is the nature of the market.
I do not think that you can ever have a market where there is some good news and it will get immediately reflected on the stock prices. Nature of the markets are not such and this is where equity is very interesting. I don’t have five bad points of the market to give you. I can give you ten good points and the most important point is that finally at the end of the day, the government is supportive and they are doing all they can in terms of supporting various industries.
So much is being done for the real estate and NBFC sectors, so much is being done for recapitalisation of banks. But the effect of this will take a little while to come. It is not that you make an announcement and the fundamental effect will be there from tomorrow morning. I am sure there will be many more measures from the government side.
One thing which I was watching very keenly is disinvestment. At the end of the day, to do anything meaningful, even the government needs resources. The strategic sale of at least a few companies is happening because in India we are in a very peculiar situation wherein the government’s balance sheet is very strong but the P&L is weak. If the government really decides to use this balance sheet, there is absolutely no problem.
All the talk about fiscal deficit can be a thing of the past, but if they decide to do it and this time around, they will get some good value because the companies are large and they are throwing a lot of money and it is coming on a global backdrop. There has been $15 trillion of bonds trading in negative yield. If you have good assets, I am very sure there will be lots of buyers.
What I am keenly watching out for is that the first real strategic disinvestment happens to a private party -- be it a foreigner or a local company. That will rekindle a lot of confidence among market players.
So no IOC and HPCL…
Yes I hope not.
The tax cut stopped the market from a fall in the end of September. Can a strategic disinvestment light the fire and will that unleash the bull markets?
I think so and that is the most important thing because at the end of the day, the government wants to do a lot of things but they need resources but where can the resources come from? This is a simple math. Rs 1,05,000 crore is the disinvestment target for this year. If I take it for the next five years of the full term of this government, the total disinvestment target will be something like Rs 7 lakh crore, assuming that you are sticking to the fiscal deficit. There is a roadmap of that fiscal deficit, maybe Rs 6.5-7 lakh crore. Now even if you assume the government stake in companies will go below 51%, even to 26%, still you cannot make Rs 7 lakh crores of disinvestment through the natural route which has been followed by the disinvestment ministry till now.
So the only choice, in my view, is strategic disinvestment and it has to happen but the whole question is how does this strategic disinvestment happen? Does it happen to a third independent foreign player, a domestic player or among government companies?
In cricket terminology, it is said that depending on the pitch, you need to bat front foot or back foot. Looking at the macro, the current market level and the data point of valuations will also come in. Should a long-term investor take a risk and bat on the front foot?
I would say yes. You must take risk selectively. We have seen that there can be a lot of gap between the fundamental and the stock prices. One needs to take a more systematic approach of not putting everything which you like and then hope that the markets will go up. Maybe, you can take a more systemic view and the next three, four months will be a real good time to buy selective stocks.
We have seen time and again that it is not important to identify even an industry, forget market, since there is such polarised performance even within the same industry. One stock is up 1,000% and the other is down. What is most important at this point of time is to identify the winners of tomorrow and then stick your neck out and say I am a long-term investor here, I will bet on this company and I will be with this company for the next three to five years.
You and I have been in this game for long enough, we have seen how the reward comes from that level of conviction and that level of work which you do on bottom up companies. When you buy them in these kind of times, when there is gloom and doom all around, obviously you are getting it at a more discounted price than normally you will get in a good market.
A select handful of stocks, which you can count on your fingertips, are trading at disproportionate premium and outperformance has been disproportionate here. Titan, Bajaj Finance, Reliance, HUL, Nestle, Kotak are largecap stocks but the outperformance in the last three years has been nothing short of breathtaking. How much more this polarise nature of the market will continue?
Today investors, specifically, the institutional investors, are hiding in these companies. These are companies which were benefiting from what is happening on a fundamental basis. If there are 30 banks and 25 of them have stopped lending, the five banks which are lending money they are able to choose the customer and able to dictate the rates. The environment is very positive for them to grow.
Also the tax cuts would benefit some of these large companies a lot. So, this performance is not in thin air. The environment is very conducive for these companies to do well. Some of these companies may continue to do well. While I would say that the bracket two, which is what we have identified, are companies which perception-wise, have fallen a lot, the fundamentals are not a problem and you can find them in all industries, in NBFCs, in pharma, in the PSU basket and even in consumption.
I would say that this polarisation will continue for some more time till there is real clarity that we are really in a bull market and all these worries which are being talked about in the market recedes. Till that time, investors will find it very convenient to continue to invest in these largecap companies.
For every expert, the last catchword in the last one month, has been yeh kamane ka time nahin hai, yeh bachane ka time hai barabar, (it is not the time to earn, it is the time to save) because those who have managed to save capital in the last one, one and a half year, knows that he would turn out to be a winner because the market will present that opportunity and people who have been very wise, and who have actually invested in these large companies in the last one, one and half year, not only have they protected their capital, but have also been able to make money even in these markets.
When did you see a similar kind of market in the last 30 years?
I have not seen this level of wealth destruction.
Not even in 2008?
No not at all. See, in 2008 we were convinced that the markets are bad but economy was not in this kind of a shape. But this time around, there is nazar hati ki durghatna ghati, ki aap ne kuch bhi thoda bhi galti kiya (the moment you look away, there is an accident. If you make a simple mistake) you can lose your entire capital.
There are at least 100 companies out of that list which have fallen more than 95% from 2018 highs, 100 companies. I have not seen this level of wealth destruction and some of them are not necessarily bad business or bad management. It is just they have caught in the leverage, promoters have got leverage, they could not get refinance so their shares got sold.
The businesses have got leverage and they could not find refinance in the business itself so business got into cycle and third are category where they had to receive a lot of money from the government and now if the government is not paying them the money, how do you pay to the banks? This time around, the cycle has been very vicious. I would say there has been a humongous amount of wealth destruction.
Can it get really get worse before it gets better for the economy and for the markets?
The possibility is always there but my hunch is also the level of pessimism which is around today. Anyone you meet, people are so nervous and so pessimistic that my gut tells me that all that pessimism, all the fear is reflected in the stock prices. If you are telling me to bet today, I will bet more on optimism rather than pessimism. I will bet that things will improve from here rather they will deteriorate. It will take time.
Let us not forget this level of wealth destruction which has happened. If a patient goes to an ICU, he does not start running even after getting cured. So there is a process. Markets are going to be like that only. I do not expect fireworks but things will start to stabilise and what I am hearing from all my friends is that October has been good for a lot of companies at least since the beginning and the government has also started releasing funds from 15th September to a lot of sectors and companies. Payments which were stuck have started being released.