2 banks that promise to be super-outperformers in next decade: Deepak Shenoy
Growth potential is good in large banks but it is much bigger in next rung of banks, says Shenoy
- Whenever earnings pick up, money will start flowing back into India: Swati Kulkarni, UTI AMC
- Nifty target at 12,000 for CY19 but will raise it if multiples get re-rated: Ravi Sundar Muthukrishnan, Elara Securities
- Don't expect too much volatility before election results: Gopal Agrawal, DSP Investment Managers
Do you still fear that volatility and weakness may kick in or is it a pre-election rally playing out which will sustain until next month?
I do not know if this is going to last till elections but to be fair there has been a lot of activity, especially from foreign institutions who have been putting in money at a comparatively good pace.
There has been a lull in domestic investments but that will also pick up. To a certain extent, I do not call this a rally but more like market had probably overshot on the downside for a lot of the midcaps and the smallcaps and that is correcting furiously.
We have seen some impact on the largecaps as well. Whether it will last till elections, I do not know. The bond markets do not seem to be as excited as the equity markets are. So when they are excited as well, that is when I will say this rally will last.
Money is flowing into equity and despite dollar index showing signs of strength around 97 odd levels, we are seeing strength in rupee as well. What are the FIIs thinking which DIIs are probably missing out?
The interesting thing here is what RBI did with the swap yesterday that will probably create a lot more interest. This effectively opens a carry-trade for anyone trying to invest in India because RBI is giving you a fixed swap.
We do not know at what rate but if it comes in at 4%, then the differential between a borrowing abroad and investing in India becomes only 4%. If that were the discovered rate, that is a huge carry because India’s interest rates are way higher than any of the interest rates in the west. You could borrow in the west at 3%, have a 4% carry and deploy in India. Even in safe instruments, you seem to be able to get 8.5%. You will get a decent 1.5%, 2% carry which is quite huge if you ask me.
This will create interest in the rupee and therefore the rupee will naturally try to correct while this is swap is on. I feel the rupee will remain strong now despite any external dollar strength as long as the swap is on and might carry on based on the discovery of the swap price and the intension of the RBI to do more such swaps.
Does the swap remove the currency risk?
Yes what it effectively says is if you were a bank and I were to give you $100 million that I have borrowed at 3%, you can look at me and say I will convert it to rupees and invest it in India at 9%, but I have the risk of the dollar running away! If the dollar were to depreciate more than 6% in interim, they will lose money. The swaps currently mean the exchange rate, the forward exchange rate typically is 5% to 6% above the current dollar rate. So, you paying 6% a year implicit depreciation assumptions with a three-year swap. You assumption will be little crystallised into reality in the sense if I give you dollars today, you will have to return me dollars but you know the cost of three years of holding those dollars that can be converted back to dollar at say 3.5% per year premium means if I do the swap at Rs 77 and current rate is Rs 69, in three years, we are talking about 11% depreciation which translates to 3.5% per year.
At 3.5% per year depreciation, if I am lending out at 9%, my effective interest rate in dollar terms is 5.5%. Now 5.5% is an awesome rate to offer to anybody in dollar terms even today. So, the carry becomes a very interesting proposition. The last time this was done was in 2013. We saw this being done at borrowing. People put $10,000, the banks gave them another $90,000 dollars as a loan at 3% interest rates and they took that money and deployed it in India. They got an IRR of 20% to 24% on their capital. This is the kind of thing that is likely to happen now as well and therefore keep the rupee-dollar exchange rate tilted towards the rupee while this swap is on.
You are betting on a potential recovery in auto. Select names have also been standing out lately on the charts. What are you betting on?
We are looking at some interesting players in the auto space; not necessarily just manufacturers but also ancillaries. People like Balkrishna Industries which has been beaten down quite a bit. It is an old favourite of ours. It continues to be on our radar on the buying side.
They have actually been trying to circumvent any issue that might happen in the US in terms of blocking Indian imports or introduces taxes on Indian imports by setting up a plant in the US as well and they have significant amount of exports to Europe right now and also at local market.
That is one company that I feel is useful to look at from investment perspective. A disclosure we are invested. We are also looking at auto manufacturers in the two-wheeler side and also some of the commercial vehicle plays.
The business cycle saw a lull in the last six months because of insurance issues and because of commercial vehicle axle load increases. We feel the effect of that weans after February and in March, the data will start to look more attractive. The February data was actually a little more attractive than we thought but still negative. From March to April, we will start to see much better data. I believe recovery in auto will come in. Elections are a benefit but a very short term one, but structurally auto is very strong bet for us for the next five years.
With the Nifty Bank at an all-time high. The contributors have been the usual suspects – HDFC Bank, ICICI, Axis and to some extent SBI. Would you be willing to stretch your list to include B rung names or stick to quality?
The real power is in the next rung of banks, so we are long RBL. We are also long Bandhan through Gruh. We have actually bet on the merger here and we are also positive on City Union Bank and DCB Bank. The smaller private sector banks if you may. The reason is I think growth potential is good in large banks but it is much bigger in RBL and Bandhan largely because they start from a relatively smaller base and the way they are doing things, both Bandhan and RBL leads us to believe that they will be super outperformers in the next decade.
They will perhaps take a lot of market share eventually from the large banks and while we do not say that investing in large banks is bad, we just feel there is more potential here.
The smaller banks like DCB and CUB are actually either candidates for acquisition if that ever happens. But their standard growth itself gives them so much room for improvement from where they are and since many of the public sector banks are still not capable of performing or gearing up, we continue to feel positive in those spaces. But again as a disclosure we have recommended or own these names. We also own a bunch of NBFCs which bet on banks not participating in some of those places as well.
On the index, what kind of contribution are you expecting when we are looking at rally building up ahead of elections?
Banks are functioning properly because we are looking at lot more liquidity infusion coming from RBI. There is a bunch of new things. Essar issue has been resolved. To a certain extent there have been more resolutions coming their way. So perhaps, end of the corporate downcycle may be near.
But there is also the fact that many of the NBFCs are crippled. They are not lending and so the private banks tend to get some of that benefit. They will do well. The good NBFCs will do well. I believe auto will recover.
By September, we should start seeing roaring fundamentals. Probably the markets will react earlier than that.
We believe that consolidation in the telecom space will show good results eventually for Bharti Airtel. Again as a disclosure, we have recommended it and Reliance will now start moving more towards a digital play than it is currently, which is mostly an industrial play.
So in the next three or four years, I believe that will continue to emergw. Reliance is a relative underperformer in terms of valuation when it comes to digital place per se. The digital part of Reliance will be game changer in the next few years. That is where I think most of the action is likely to be.
L&T and stocks like ABB perhaps and some of the other capital goods players should do well immediately after elections because once you have certainty of who is going to be on the throne for the next five years, people will start capex plans.
Lots of capex jave been bunched out or people have not invested in capex in the last three years because of the deleveraging cycle and that never lasts forever. So, people will start announcing new plans. We are seeing a lot of foreign interest in Indian capex by participating either partly or fully in construction projects from Abu Dhabi, Singapore and a bunch of hedge funds abroad. That is going to drive the capex cycle as well. L&T and a couple of capital goods players are worthwhile to look at.
From the broader markets, what is looking interesting to you?
In the broader markets, we are long on lots of midcaps. We still feel that there is a lot of potential here. We have talked about the auto space. We are really interested in the start-up space. We have been long Naukri, which is Info Edge. One of the reasons for this is not just that it is a cash earning business, also from its primary proposition as a jobs portal and some of the secondary portals like 99acres or Jeevansathi, they invest a significant amount of money into other start-ups. They own 28% or 26% now of Zomato and they have significant stake in Policybazaar and because of this ownership and those companies’ ability to raise capital at higher valuations and perhaps provide a stronger base, we are interested in Info Edge.
Zomato at $3 billion plus is perhaps a bigger valuation than Naukri. Their stake in these start-ups contributes to more than half of their market cap right now and if these start-ups were to grow even more, you might actually be buying the base business at a ridiculously low valuation.
I feel longer term there is still a lot of value in this and we are looking at start-ups in India and you are saying that I wish I had invested in any of these start-ups. One proxy way to do that is perhaps to buy companies like Naukri which effectively are investors in many of these start-ups.
The other set of investments we are looking at there are some pharma plays. I cannot take all the names. We are still buying bunch of them. But I think here you should look at companies that have deleveraged in terms of debt to equity substantially in the last three years and where promoter pledging is relatively small or non-existent.
I have talked about Balkrishna which did that last year, announced large capex plans for the future. We have seen a bunch of others like GNA Axles. It is a smallcap in the commercial vehicle axle manufacturing space which has also announced new capacity that has been coming. We have looked at JK Paper and a number of paper industries. JK Paper has expanded by buying another paper company in the NCLT and perhaps half of what it would get if it had to build that capacity by itself and therefore has managed to expand. It is running at 110% capacity today and so the expansion will help it.
You should be clearly careful about investing in companies that are not really so much focussed on building PR around media as much as they are on growing their core business. In a bull run, you always find a lot of management very focussed on convincing investors to invest in the companies rather than on running their business.
We have been through a cycle in the past one year where that has failed miserably and we should not hurt like that in the next few years. Always look at businesses that are deleveraging or have deleveraged.