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Until economy recovers, midcaps won’t rebound: Deepak Shenoy

If you are bullish on India in the long term, then we will wait. I am not saying that it is not happening overnight, but it is something you should take cognisance of and build portfolios for 2025-2026 now. But you should understand that there will be pain in the short term. The value for midcaps is extremely good now.

ET Now|
Updated: Dec 16, 2019, 05.30 PM IST
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Unless there is an actual increase in GDP, the issues with consumption, exports are going to be strong. This should not be construed as a fundamentals driven rally, says Deepak Shenoy, Founder, Capital Mind. Excerpts from an interview with ETNOW.

It is a countdown to the Budget now. How do you see us kick-starting the year?
It will be quite interesting. The Budget, is one of the few budgets where there is a certain amount of headroom to do some policy actions. Unfortunately, fiscal space is not quite that much. But having said that, some larger announcements may be possible because from a political angle, it will give them four years to see the results of the policies. Right now, everybody is talking about a personal tax cut again.

I do not know whether it is politically a big deal because less than 0.3% of the population will actually get impacted by lower taxes but something else in terms of investment proposals in terms of changes in the way the government finances itself would be a welcome move. We do not know how GST will pan out, but I do not think that is going to be decided by the budget. It is going to be decided mostly by the GST Council.

Do you think earnings expectations are pretty high or it is mainly the runup to the Budget?
It is a liquidity fuelled Budget. Money is being printed all over the world by central bankers, including in India. This Rs 300,000 crore extra cash that banks have parked with the RBI at roughly 5% a year, is the lowest interest rate that they possibly get in the country and banks are choosing to do that to people. That means this is just excess supply. People are not spending, they are investing and that is causing more money to come into markets and probably fuelling the rally.

Unless there is an actual increase in GDP, the issues with consumption, exports are going to be strong. This should not be construed as a fundamentals driven rally. In terms of valuations, these are probably higher than most of the US markets because the US markets are at an all time high. Their growth is much better and their valuations in terms of earnings multiples is a little bit lower than India. I think this the only thing that will take this market down. It is going to be a lack of liquidity. I do not foresee an event like that in the near future.

What is the main problem as far as midcaps are concerned?
The issue really is it is going to get worse because now brokers have been restricted from giving a lot of leverage, starting January 2020. A lot of midcap and smaller cap companies which depend on many of the larger institutions do not buy them because they are too small. If you buy a 10% of a Rs 3,000-crore company, that is Rs 300 crore, if you are a mutual fund that has Rs 30,000 crore, you know owning 10% of this company will be insignificant compared to your overall investment or AUM. So they focus on the larger caps. Rs 3,000 crore is generally played by smaller companies and may be some PMS companies.

The retail individual investor, has his liquidity trimmed by a number of factors including regulation. Their money largely comes from business and therefore that has come out because of the spending we have seen across the population. Until the economy recovers, we are not going to see midcaps recover substantially though I think it is a good time to buy them because the value is extremely good value.

If you are bullish on India in the long term, then we will not await a little while I am not saying that it is not happening overnight but it is something I think you should take cognisance of and build portfolios for 2025-2026 right now, while understanding that there will be pain in the short term.

Are you banking on the government building its coffers from here because there is a divestment drive for BPCL, Shipping Corp, ConCor? How do you expect it to move from here? How do you expect PSU stocks to perform going ahead?
There is a huge amount of value in all of these companies that is going to be unlocked by a third party player. Even in case of BPCL, the government is going to sell it, but the cross-ownership of stakes in other public sector companies will have to be compensated. So, they will probably sell that to other public sector enterprises. That brings in money into BPCL.

Apart from that, there is another refinery in Assam that they do not want to give up. That is going to be sold again to another party and that again is going to give some more money into BPCL. Apart from BPCL, there are a number of other assets which are non-operating as well from real estate to others.

So, there is a significant amount of value that can be unlocked for BPCL and in terms of building a better price for BPCL going forward, these are good moves because it will give a fairly large chunk of money to the government both from a disinvestment angle and also for potential future avenues of this sort.

The issue really is in the timeline and I do not think this will happen in the next three or four months, it will take about a year for any kind of acquisition to be completed.

Based on this action there will be more that the government would want to sell. I believe that the government should explore issuing euro bonds because they are available at a relatively low, less than 1% size for even our credit rating. If they are able to do that, the fiscal room would improve quite substantially because we are actually trading at 7% nearly on the 10-year bond.

The difference is quite substantial. I also feel that over time, tax recovery will come but I do not think we should bank on taxes for the next one year at least so sell as many non-required assets as possible, including government holdings in L&T and ITC. They don’t need to be owning those companies and they should sell them.

What about auto? We were discussing this a fair amount last week given all those comments around green shoots and price hikes so and so forth. Do you feel the worst is over now? Would you look at select plays?
The data definitely indicates there is some kind of recovery happening from the lows. August was the lowest number we have seen recently and then every month since then, has been a little bit better. Having said that, it also has something to do with BS-VI impact.

You are going to see deliveries being pushed out faster now because you cannot sell the non BS-VI car or register it after April 1. You would want to get rid of the inventory as soon as possible. It is part of that sales push happening now.

I believe that has got a lot of headroom where auto growth is concerned because we have hardly scratched the surface. We have gone in the metros where we have a little bit of congestion in terms of auto ownership. But if you look at the country as a whole, India is relatively under-owned both in two-wheelers and four-wheelers. Commercial vehicles will benefit in the longer term as more roads are built.

It will take some time for commercials to recover but overall, the 10-year cycle is probably good to buy auto companies selectively where including auto OEMs, some of their peers earnings multiples have come down to three, four, 10, five whereas in the past, they have seen much better earnings multiples with high return on equity.

It is time to buy. Do not expect magic or miracles in the next six months or next one year also but if you are planning to hold for the long term, this is a very reasonable sector to look at.

Some of these pharma names are in the news. The word is they could be the surprise leaders in 2020. What do you think?
It would be a surprise to me as well but there are FPI challenges and that is one of the key criteria; election outcome in the US is also as a lot of promises would be made. Some of those promises could impact these companies negatively. The popular opinion is that drugs manufactured in India are not as good although nobody admits it. So, it is one of those things which will be a challenge next year.

I do not think a lot of the FDA action is going to go away in the next three or six months. Some of it is going to remain or linger around for longer. Within India, we had a lot of talks about price limits set on certain drugs. We are coming out of that right now and there is a bunch of relaxations that have been put but you could see some changes in that as well going ahead.

A number of challenges are there. I will be surprised positively if pharma leads the pack but that does not look like it right now.

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